solution manual advanced accounting 9th edition by baker chapter 11

Chapter 11 - Multinational Accounting: Foreign Currency Transactions And Financial Instruments

11-1

CHAPTER 11 MULTINATIONAL ACCOUNTING: FOREIGN CURRENCY TRANSACTIONS AND

FINANCIAL INSTRUMENTS ANSWERS TO QUESTIONS Q11-1 Indirect and direct exchange rates differ by which currency is desired to be expressed in another currency. An indirect exchange rate is the number of foreign currency units that may be obtained for one local currency unit. The indirect exchange rate has the foreign currency unit in the numerator. As a fraction, the indirect exchange rate is expressed as follows:

Number of foreign currency unitsOne local currency unit

A direct exchange rate is the number of local currency units needed to acquire one foreign currency unit. The direct exchange rate has the local currency units in the numerator (the U.S. dollar for the direct exchange rate for the U.S. dollar). As a fraction, the direct exchange rate is expressed as follows:

Number of local currency unitsOne foreign currency unit

The indirect and direct exchange rates are inversely related and both state the same relationship between two currencies. Q11-2 The direct exchange rate can be calculated by taking the inverse of the indirect exchange rate. Such a computation follows:

Number of foreign currency units = C$1.3623 (Canadian dollars)One local currency unit $1.00 (U.S. dollars)

The inverse of the indirect exchange rate is:

$1.00 (U.S. dollars) = C$1.36 (Canadian dollars) $0.7340 Q11-3 When the U.S. dollar strengthens against the European euro, imports from Europe into the U.S. will be less expensive in U.S. dollars. The direct exchange rate decreases, indicating that it takes fewer dollars to acquire European euros.


11-2

Q11-4 A foreign transaction is a transaction that does not involve the exchange of currencies on the part of the reporting entity. An example of a foreign transaction is the sale of equipment by a U.S. company (the reporting entity) to a Japanese firm that is denominated in U.S. dollars. A foreign currency transaction is a transaction that does involve the exchange of currencies on the part of the reporting entity. An example of a foreign currency transaction is the sale of equipment by a U.S. company (the reporting entity) to a Japanese firm that is denominated in Japanese yen. Q11-5 There are many types of economic factors that affect currency exchange rates, among which are the level of inflation, the balance of payments, changes in interest rates and investment levels, and the stability and process of governance. One example of an economic factor that results in a weakening of the U.S. dollar versus the European euro is a higher level of inflation in the U.S. relative to the inflation in Europe. Q11-6 Assets and liabilities denominated in a foreign currency are measured according to the requirements in FASB 52 for those arising from normal purchase and sale transactions, and by FASB 133 for forward exchange contracts and hedging activities. FASB 52 specifies that the valuation at the transaction date and each subsequent balance sheet date should be at the local currency equivalent using the spot rate of exchange. Forward exchange contracts are valued at fair value, typically by using the forward rate for the remainder of the term of the forward contract. Q11-7 Foreign currency transaction gains or losses are recognized in the financial statements in the period in which the exchange rate changes. These gains or losses are reported on the income statement. Q11-8 If the direct exchange rate increases, the Sun Company will experience a foreign currency transaction loss on its $200,000 account payable that is denominated in Canadian dollars. The increase in the direct exchange rate shows that the U.S. dollar has weakened relative to the Canadian dollar, requiring more U.S. dollars be used to pay the debt owed. Q11-9 Four ways a U.S. company can manage the risk of changes in the exchange rates for foreign currencies are to (1) use a forward contract to offset an exposed foreign currency position, (2) hedge a firm foreign currency commitment as a fair value hedge, (3) hedge an anticipated foreign transaction as a cash flow hedge, or (4) speculate in foreign currency markets. One example of a U.S. company hedging against the risk of changes in the exchange rates for foreign currencies is to use a forward exchange receivable contract to partially offset the effects of changes in the exchange rates of the foreign currency liability. Q11-10 An exposed net asset position occurs when a company's trade receivables and other assets denominated in a foreign currency are greater than its liabilities denominated in that currency. An exposed net liability position occurs if a company's liabilities denominated in a foreign currency exceed receivables denominated in that currency.


11-3

Q11-11 A difference usually exists between a currency's spot rate and forward rate because of the different economic factors involved in the determination of a future versus present rate of exchange. This difference is usually positive because of uncertainty and conservatism toward the future. For example, if inflation is assumed to continue into the future in the foreign country whose currency is being acquired, the forward rate will be higher than the spot rate because of the decreasing purchasing power of the currency. In addition, the time value of money factor will typically result in a higher forward exchange rate than the spot exchange rate. Q11-12 (a) When an exposed foreign currency position exists, either an exposed net asset or net liability position is created. The forward contract is valued at fair value, usually by the forward exchange rate for the remainder of the term of the forward contract. The underlying payable or receivable from the foreign currency transaction is valued at the spot rate at the time of the transaction and adjusted to the current spot rate at each balance sheet date. (b) For a hedge of an identifiable foreign currency commitment, both the financial instrument and the forward contract aspects of the hedge are valued at the forward rate. An account, termed firm commitment, is created during the term of the forward contract to recognize the change in value of the financial instrument aspect of the firm commitment. (c) For a cash flow hedge of a forecasted transaction, the forward contract is valued at the forward rate, but the effective portion of the change in the fair value of the forward contract is recognized in other comprehensive income. The gain or loss on the remeasured foreign currency denominated account payable or receivable is offset from a reclassification of other comprehensive income so that there is no net exchange gain or loss from this hedge. (d) A speculative forward contract is not a hedge, but rather is a derivative that is valued at fair value by using the forward exchange rate for the remainder of the forward contract’s term.

Gains or losses on these forward contracts are recognized in income in the period in which they occur.


11-4

Q11-13 a. A foreign currency receivable from broker would be shown on the balance sheet for the period valued at its fair value by using the contracted amount of foreign currency multiplied by the forward rate.

b. A foreign currency transaction loss would be shown on the income statement at the end of the period as a separate item in the "Other" category.

c. A foreign currency transaction gain would be shown on the income statement at the end of the period as a separate item in the "Other" category.

d. A payable to exchange broker would be shown on the balance sheet for the period valued at the contracted amount of foreign currency multiplied by the forward exchange rate. This is the dollar amount agreed upon by the forward contract and will not change during the term of the forward contract.

e. A premium on forward contract is not separately accounted for but rather is indirectly included in the gain or loss through the process of revaluing the forward contract from its forward rate at the time the contract is entered into to its eventual fair value using the spot rate at the maturity date of the forward contract.

f. Foreign currency units will be shown on a U.S. company's balance sheet as an investment at their U.S. dollar equivalent value as of the balance sheet date. The U.S. dollar equivalent value is determined using the spot rate at each balance sheet date.

g. Accounts payable denominated in a foreign currency would be shown on the balance sheet for the period at the contracted amount of foreign currency multiplied by the current exchange rate. Note that FASB 52 requires that the spot rate be used for foreign currency-denominated payables or receivables arising from normal operating transactions, but that FASB 133 requires that forward exchange contracts be valued using the forward rate.


11-5

SOLUTIONS TO CASES C11-1 Effects of Changing Exchange Rates a. The major factors influencing the demand for the U.S. dollar on the foreign exchange markets are (1) rate of inflation, (2) the interest and investment rates, (3) balance of payments, and (4) alternative investment opportunities. For example, the demand for the U.S. dollar weakens as inflation rates increase, interest rates decrease, the balance of payments becomes an increasingly high deficit, and alternative investments in other countries are more readily available. b. As the dollar drops in value in relation to other currencies:

(1) Exports from the U.S. to the other country become less expensive and foreign buyers tend to increase their orders for U.S. goods. For example, assume the U.S. dollar weakened relative to a foreign currency unit (FCU) as follows:

direct exchange rate = $.50 / 1 FCUafter weakening = $.60 / 1 FCU

This would mean that a U.S.-manufactured machine selling for $10,000 would cost the foreign customer 20,000 FCU before the weakening of the dollar ($10,000 = 20,000 FCU x $.50). After the weakening of the dollar, this same machine would cost the foreign customer 16,667 FCU ($10,000 = 16,667 FCU x $.60). This means a significant price reduction for the foreign buyer, thereby increasing the foreign demand for the U.S.-manufactured machine.

(2) The opposite effect occurs for the U.S. business firm as the dollar weakens. Foreign-made goods are now more expensive as it takes more dollars to acquire imports. For example, a foreign-made part selling for 10 FCU before the weakening costs the U.S. company $5.00 ($5.00 = 10 FCU x $.50). After the dollar weakens, the same part now costs the U.S. company $6.00 ($6.00 = 10 FCU x $.60). This increase of $1.00 per part is due solely to the weakening of the U.S. dollar relative to the foreign currency. Nevertheless, the U.S. business firm is subject to a very significant increase in the cost of its inputs.

c. As the dollar weakens, imports become more expensive for the U.S. consumer. In addition, as in case b(2) above, the U.S.-based manufacturer using foreign-made components for its products must now pass the higher costs on to its customers. Thus, U.S. consumers have to pay higher prices for their goods that have foreign elements.


11-6

C11-2 Reporting a Foreign Currency Transaction on the Financial Statements [AICPA Adapted]

a. Bow should report a foreign exchange loss on its 20X5 income statement. This loss is calculated by taking the number of pounds that are due in 20X6 and multiplying them by the change in the direct exchange rate from the transaction date to the balance sheet date. Since the U.S. dollar weakened, the direct exchange rate on December 31, 20X5, would be higher than the direct exchange rate on November 30, 20X5. The increase in the direct exchange rate means that more U.S. dollars would be needed to purchase pounds at December 31, 20X5, than at November 30, 20X5. Therefore, a foreign currency transaction loss should be reported in 20X5 because the exchange rate changed during 20X5. In addition, the accounts payable denominated in pounds should be reported at the exchange rate at December 31, 20X5. This means that the accounts payable recorded on November 30, 20X5, would have to be increased in order to reflect a weakening U.S. dollar. b. Reporting a foreign exchange loss in 20X5 is appropriate because, consistent with accrual accounting, the exchange rate on December 31, 20X5, should be used to value the accounts payable denominated in pounds. Bow's beliefs as to future exchange rate movements are excluded from the financial statements. C11-3 Changing Exchange Rates Note to Teacher: Currency exchange rates may be found in a variety of places on the Internet. A good site is http://finance.yahoo.com/currency. Note that to obtain the direct exchange rate, students will have to specify the conversion as the foreign currency units into U.S. Dollars. After clicking the link for the conversion, both the current exchange rate and a chart of historical exchange rates are presented. There are various options for the length of time shown on the chart; the student should select the 2-year chart. Other sites can be found using a search engine and search terms such as “historical currency exchange rates.” From January, 2005 through January, 2006, the dollar strengthened against the yen. From January, 2006 to July, 2006, the dollar weakened against the yen. A major factor is the trade imbalance between the U.S. and Japan. The Japanese economy appears to have emerged in 2006 from years of stagflation and economic growth has risen steadily. From mid-2004 to early 2005, the dollar weakened against the euro. During 2005, the dollar strengthened against the euro, but in 2006 the trend appears to have reversed. The major factors are the trade imbalance between the U.S. and the European countries and the steady rise in U.S. interest rates, high energy prices, and fears that inflation may be rising. From mid-2004 to early 2005, the dollar weakened against the British pound. During 2005, the dollar strengthened against the pound, but in 2006 the trend appears to have reversed. Factors include the steady rise in U.S. interest rates, high energy prices, and fears that inflation may be rising. The United Kingdom’s trade with other members of the EU continues to increase.


11-7

C11-3 (continued) In the period 2004 through 2005, the dollar weakened against the peso, but strengthened in 2006. Mexico’s economy is very volatile because of its reliance on U.S. trade and on its trade relations with countries such as Brazil and Argentina. C11-4 Accounting for Foreign Currency Denominated Accounts Payable MEMO TO: Marie Lamont, Manager, Mardi Gras audit From: ______________ _______________, CPA Re: Mardi Gras Corporation’s Foreign Currency Transactions Our client, Mardi Gras Corporation, needs to change its method of accounting for the effects of changes in the exchange rate for Swiss francs. Currently, any difference between the liability recorded when the merchandise is received and the amount that is paid (in U.S. dollars) when the liability is settled is recorded by our client as an adjustment to the cost of the inventory purchased. However, this difference is the result of changes in the exchange rate for Swiss francs between the date of the inventory purchase and the payment date and is not the result of changes in the price of the merchandise. Mardi Gras’s purchases from the Swiss company are foreign currency transactions that result in Mardi Gras recording a payable denominated in Swiss francs. The liability is fixed in terms of the amount of Swiss francs that must be paid. Mardi Gras is recording the payable appropriately since they are using the exchange rate on the date of the inventory purchase to convert the francs to dollars. This is consistent with requirements in FASB Statement No. 52. However, the accounting for subsequent changes in the U.S. dollar equivalent of the Swiss franc liability is not acceptable. Rather than an adjustment to the cost of inventory, changes in the liability that result because of changes in the exchange rate between the U.S. dollar and the Swiss franc must be recognized as a foreign currency transaction gain or loss and must be included in net income in the period in which the rate change occurs. Mardi Gras should also be aware that any outstanding foreign currency payables at the balance sheet date should be adjusted to their U.S. dollar equivalent using the exchange rate in effect on the balance sheet date, with any resulting foreign currency transaction gains or losses included in earnings of the current period. Disclosure of the aggregate gain or loss from foreign currency transactions used in determining net income for a given period is also required.


11-8

C11-4 (continued) Authoritative support for the above memo can be found in the following references: FASB 52, Par. 15, Par. 16, and Par. 30 Suggested Queries: exchange rate* change* transaction gain* disclos

C11-5 Accounting for Foreign Currency Forward Contracts MEMO To: Lindsay Williams, Treasurer From: __________ ___________, CPA, Assistant Treasurer Re: Financial Statement Effects of Foreign Currency Forward Contract Avanti has entered into a contract to purchase equipment for a fixed price of 4.5 million euros. This agreement meets the definition of an unrecognized firm commitment that has both contractual rights and contractual obligations. The fixed price of the firm commitment exposes the company to the fair value risk of changes in the price of the equipment. However, because the purchase price is denominated in euros, the contract also exposes the company to the risk of changes in the value of the foreign currency. The company may enter into a derivative contract. FASB Statement No. 33 allows such a derivative contract of a foreign currency exposure of an unrecognized firm commitment to be designated as a hedge. If Avanti elects to use a forward exchange contract to fix the exchange rate to purchase euros, the company can designate the forward contract as a foreign currency fair value hedge of the foreign currency exposure in the firm commitment if there is formal documentation of the hedging relationship and the rationale for the management’s decision to use the hedge, and if the effectiveness of the hedge is assessed before every reporting date and at least every three months. If the forward contract qualifies as a foreign currency fair value hedge, the gain or loss on the hedge and the offsetting gain or loss on the hedged firm commitment should be recognized in earnings in the same accounting period. Therefore, during the commitment period, there will be no effect on the income statement; the gain or loss on the derivative will be offset by the loss or gain on the firm commitment. After the equipment is delivered, a foreign currency denominated payable will be recorded and accounted for under FASB Statement No. 52. Transaction gains or losses on the foreign currency liability may continue to be offset by changes in the fair value of the forward contract.


11-9

C11-5 (continued) Authoritative support for the memo can be found in the following references: FASB 133, Par. 4, Par. 4 (footnote), FASB 133, Par. 18(d), and FASB 133, Par. 20 Suggested Queries: hedg* foreign currenc* commitment* hedg* accounting criteria C11-6B Accounting for Hedges of Available-for-Sale Securities MEMO To: Mark Becker, CFO From: ___________ _______________, CPA, Investment Division Re: Hedge Accounting—Bond Portfolio The proposal has been made to use an interest rate futures contract to hedge the interest rate risk associated with Rainy Day’s portfolio of bond investments. Although the use of the derivative may be expected to offset the changes in the value of the bond portfolio, the issue that must be considered is whether the use of this derivative would qualify for hedge accounting under FASB Statement No. 133. If hedge accounting cannot be used, the changes in the fair value of the futures contract will be included in net income. However, the changes in the fair value of the bond portfolio will continue to be reported as other comprehensive income, but not in net income. FASB 133 does allow a portfolio of similar assets or similar liabilities to be designated as the hedged item under certain conditions. The change in value of any item in the portfolio must be generally proportionate to changes in value for the entire portfolio. To meet this condition, Rainy Day should be able to demonstrate that the values of the individual bonds within the portfolio respond to interest rate changes in a proportionate manner to the overall portfolio response. Given the wide range of maturity dates on the bonds in the portfolio, this condition may be difficult to meet. If the aggregation criteria are not met, Rainy Day could consider aggregating bonds of similar maturities into several sub-portfolios and using multiple derivatives to hedge the interest rate risk associated with each group of bond investments. This subdividing of the bond portfolio would also make it easier to demonstrate if the hedge is effective. If hedge accounting is allowed, the effect on earnings of the derivative will be offset by the changes in the fair value of the bond investment.


11-10

C11-6B (continued) Authoritative support for the above memo can be found in the following references: FASB 133, Par. 18, Par. 20, Par. 21, Par, 23 FASB 115, Par. 13, amended by FASB 130, Par. 3 Suggested Queries: hedg* criteria “available-for-sale”


11-11

SOLUTIONS TO EXERCISES E11-1 Exchange Rates a. Indirect exchange rates for pounds and dollars: $1.00 = .625 British pounds (1 pound / $1.60) $1.00 = 1.3514 Canadian dollars (1 Canadian dollar / $.74)

b. FCU = $

= $8,000

= 5,000 British pounds Direct Exchange Rate $1.60

c. 4,000 Canadian dollars x $.74 = $2,960 E11-2 Changes in Exchange Rates a. Exchange rates:

Arrival Date Departure Date

Direct Exchange Rate

1 florin = $.20 ($200 / 1,000 florins)

1 florin = $.15 ($15 / 100 florins)

Indirect Exchange Rate

$1.00 = 5 florins (1,000 florins / $200)

$1.00 = 6.67 florins (100 florins / $15)

b. The direct exchange rate has decreased. This means that the dollar has strengthened during Mr. Alt's visit. For example, upon arrival, Mr. Alt had to pay $.20 per each florin. Upon departure, however, each florin is worth just $.15. This means that the relative value of the dollar has increased or, alternatively, the value of the florin has decreased.

c. The U.S. dollar equivalent values for the 100 florins are:

Arrival date 100 florins x $.20 = $20Departure date 100 florins x $.15 = 15Foreign Currency Transaction Loss $ 5

Mr. Alt held florins for a time in which the florin was weakening against the dollar. Thus, Mr. Alt experienced a loss by holding the weaker currency.


11-12

E11-3 Basic Understanding of Foreign Exposure a. If the direct exchange rate increases, the U.S. dollar weakens relative to the foreign currency unit. If the indirect exchange rate increases, the U.S. dollar strengthens relative to the foreign currency unit. b. Settlement Direct Exchange Rate Indirect Exchange Rate Transaction Currency Increases Decreases Increases Decreases Importing Dollar NA NA NA NA Importing LCU L G G L Exporting Dollar NA NA NA NA Exporting LCU G L L G


11-13

E11-4 Account Balances

Foreign Currency Units (€)

From receivable: (€250,000 x $.58)

(7) 2/1/x7

145,000

To payable: (€125,000 x $.58)

(8) 2/1/x7

72,500

Bal. 2/2/x7

72,500

Accounts Receivable (€)

(€250,000 x$.60) (1) 11/1/x6 150,000

[€250,000 x ($.62 - $.60)]

(3) 12/31/x6 AJE

5,000

(€250,000 x $.62) Bal. 12/31/x6 155,000 [€250,000 x ($.58 - $.62)]

(5) 2/1/x7 AJE

10,000

(€250,000 x $.58) Bal. 2/1/x7 145,000 (€250,000 x $.58) (7) 2/1/x7 Settle 145,000

Bal. 2/2/x7 -0-

Accounts Payable (€)

(€125,000 x $.60) (2) 11/1/x6 75,000

[€125,000 x ($.62 - $.60)]

(4) 12/31/x6 AJE

2,500

(€125,000 x $.62) Bal. 12/31/x6 77,500

[€125,000 x ($.58 - $.62)]

(6) 2/1/x7 AJE

5,000

(€125,000 x $.58)

(8) 2/1/x7 Settle

72,500

(€125,000 x $.58)

Bal. 2/1/x7

72,500

Bal. 2/2/x7 -0-

Foreign Currency Transaction Loss

[€125,000 x ($.62 - $.60)]

(4) 12/31/x6 AJE

2,500

[€250,000 x ($.58 - $.62)]

(5) 2/1/x7 AJE

10,000

Foreign Currency Transaction Gain [€250,000

x ($.62 - $.60)]

(3) 12/31/x6 AJE

5,000 [€125,000

x ($.58 - $.62)]

(6) 2/1/x7 AJE

5,000


11-14

E11-5 Determining Year-End Account Balances for Import and Export Transactions

Accounts

Receivable Accounts

Payable

Foreign Currency Transaction

Exchange Loss

Foreign Currency Transaction

Exchange Gain Case 1 NA $16,000(a) NA $2,000(b) Case 2 $38,000(c) NA NA $2,000(d) Case 3 NA $27,000(e) $3,000(f) NA Case 4 $6,250(g) NA $1,250(h) NA

(a) LCU 40,000 x $.40 (b) LCU 40,000 x ($.40 - $.45) (c) LCU 20,000 x $1.90 (d) LCU 20,000 x ($1.90 - $1.80) (e) LCU 30,000 x $.90 (f) LCU 30,000 x ($.90 - $.80) (g) LCU 2,500,000 x $.0025 (h) LCU 2,500,000 x ($.0025 - $.003)


11-15

E11-6 Transactions with Foreign Companies a. May 1 Inventory (or Purchases) 8,400 Accounts Payable 8,400 Foreign purchase denominated in U.S. dollars. June 20 Accounts Payable 8,400 Cash 8,400 Settle payable. July 1 Accounts Receivable 10,000 Sales 10,000 Foreign sale denominated in U.S. dollars. August 10 Cash 10,000 Accounts Receivable 10,000 Collect receivable. b. May 1 Inventory (or Purchases) 8,400 Accounts Payable (¥) 8,400 Foreign purchase denominated in yen: $8,400 / $.0070 = ¥1,200,000 June 20 Foreign Currency Transaction Loss 600 Accounts Payable (¥) 600 Revalue foreign currency payable to U.S. dollar equivalent value: $9,000 = ¥1,200,000 x $.0075 June 20 spot rate - 8,400 = ¥1,200,000 x $.0070 May 1 spot rate $ 600 = ¥1,200,000 x ($.0075 - $.0070) Accounts Payable (¥) 9,000 Foreign Currency Units (¥) 9,000 Settle payable denominated in yen. July 1 Accounts Receivable (BRL) 10,000 Sales 10,000 Foreign sale denominated in Brazilian reals: $10,000 / $.20 = BRL50,000 August 10 Accounts Receivable (BRL) 1,000 Foreign Currency Transaction Gain 1,000 Revalue foreign currency receivable to U.S. dollar equivalent value: $ 11,000 = BRL50,000 x $.22 Aug. 10 spot rate - 10,000 = BRL50,000 x $.20 July 1 spot rate $ 1,000 = BRL50,000 x ($.22 - $.20) Foreign Currency Units (BRL) 11,000 Accounts Receivable (BRL) 11,000 Receive Brazilian reals in settlement of receivable.


11-16

E11-7 Foreign Purchase Transaction

a. Denominated in Swiss francs Rone Imports reports in U.S. dollars

12/1/X1 12/31/X1 1/15/X2

Transaction Date

Balance Sheet Date

Settlement Date

Direct Exchange Rate

$.70 $.66 $.68

b. December 1, 20X1 Inventory (or Purchases) 10,500 Accounts Payable (SFr) 10,500 $10,500 = SFr 15,000 x $.70 December 31, 20X1 Accounts Payable (SFr) 600 Foreign Currency Transaction Gain 600 Revalue foreign currency payable to equivalent U.S. dollar value: $ 9,900 = SFr 15,000 x $.66 Dec. 31 spot rate -10,500 = SFr 15,000 x $.70 Dec. 1 spot rate $ 600 = SFr 15,000 x ($.66 - $.70) January 15, 20X2 Foreign Currency Transaction Loss 300 Accounts Payable (SFr) 300 Revalue payable to current U.S. dollar equivalent: $10,200 = SFr 15,000 x $.68 Jan. 15, 20X2, value - 9,900 = SFr 15,000 x $.66 Dec. 31, 20X1, value $ 300 = SFr 15,000 x ($.68 - $.66) Accounts Payable (SFr) 10,200 Foreign Currency Units (SFr) 10,200 $10,200 = SFr 15,000 x $.68

Accounts Payable (SFr)

(SFr 15,000 x $.70) 12/1/X1 10,500AJE 12/31/X1 600 (SFr 15,000 x $.66) Bal 12/31/X1 9,900 AJE 1/15/X2 300 (SFr 15,000 x $.68) Bal 1/15/ X2 10,2001/15/X2 Settlement 10,200 Bal 1/16/X2 -0-


11-17

E11-8 Adjusting Entries for Foreign Currency Balances a. December 31, 20X6 Accounts Receivable (E£) 10,000 Foreign Currency Transaction Gain 10,000 Adjust receivable denominated in Egyptian pounds to current U.S. dollar equivalent and recognize exchange gain: $83,600 = E£475,000 x $.176 Dec. 31 spot rate - 73,600 = Preadjusted Dec. 31, 20X6, value $10,000 Accounts Payable (¥) 5,200 Foreign Currency Transaction Gain 5,200 Adjust payable denominated in foreign currency to current U.S. dollar equivalent and recognize exchange gain: $175,300 = Preadjusted Dec. 31, 20X6, value - 170,100 = ¥21,000,000 x $.0081, Dec. 31 spot rate $ 5,200 b. Accounts Receivable (E£) 1,900 Foreign Currency Transaction Gain 1,900 Adjust receivable denominated in Egyptian Pounds to equivalent U.S. dollar value on settlement date: $85,500 = E£475,000 x $.180 20X7 collection date value - 83,600 = E£475,000 x $.176 Dec. 31, 20X6, spot rate $ 1,900 = E£475,000 x ($.180 - $.176) Cash 164,000 Foreign Currency Units (E£) 85,500 Accounts Receivable (E£) 85,500 Accounts Receivable ($) 164,000 Collect all accounts receivable. c. Accounts Payable (¥) 6,300 Foreign Currency Transaction Gain 6,300 Adjust payable to equivalent U.S. dollar value on settlement date: $163,800 = ¥21,000,000 x $.0078 20X7 payment date value - 170,100 = ¥21,000,000 x $.0081 Dec. 31, 20X6, spot rate $ 6,300 = ¥21,000,000 x ($.0078 - $.0081) Accounts Payable ($) 86,000 Accounts Payable (¥) 163,800 Foreign Currency Units (¥) 163,800 Cash 86,000 Payment of all accounts payable.


11-18

E11-8 (continued) d. Transaction gain on E£: December 31, 20X6 $10,000 gain December 31, 20X7 1,900 gain Overall $11,900 gain e. Transaction gain on ¥: December 31, 20X6 $ 5,200 gain December 31, 20X7 6,300 gain Overall $11,500 gain f. Overall foreign currency transactions gain:

Gain on E£ transaction $11,900 Gain on ¥ transaction 11,500 $23,400

Chocolate De-Lites could have hedged its exposed position. The exposed positions are only those denominated in foreign currency units. The accounts receivable denominated in E£ could be hedged by selling E£ in the forward market, thereby locking in the value of the E£. The accounts payable denominated in ¥ could be hedged by buying ¥ in the forward market, thereby locking in the value of the ¥.


11-19

E11-9 Purchase with Forward Exchange Contract 3/10 6/8

Transaction Date - Account payable in C$ - Sign 90-day FEC to receive C$

Settlement Date - Receive C$ from FEC completion - Settle payable in C$

March 10 Inventory (or Purchases) 17,100 Accounts Payable (C$) 17,100 Foreign purchase of engines: $17,100 = C$30,000 x $.57 Foreign Currency Receivable from Exchange Broker (C$) 17,400 Dollars Payable to Exchange Broker ($) 17,400 Signed 90-day forward exchange contract to receive C$: $17,400 = C$30,000 x $.58 forward rate June 8 Foreign Currency Receivable from Broker (C$) 600 Foreign Currency Transaction Gain 600 Revalue foreign currency receivable to current equivalent U.S. dollar value: $18,000 = C$30,000 x $.60 June 8 spot rate - 17,400 = C$30,000 x $.58 Mar. 10 forward rate $ 600 = C$30,000 x ($.60 - $.58) Foreign Currency Transaction Loss 900 Accounts Payable (C$) 900 Revalue foreign currency accounts payable to current U.S. dollar value: $900 = C$30,000 x ($.60 - $.57) Dollars Payable to Exchange Broker ($) 17,400 Cash 17,400 Pay U.S. dollars to exchange broker for forward contract. Foreign Currency Units (C$) 18,000 Foreign Currency Receivable from Exchange Broker (C$) 18,000 Receive Canadian dollars from exchange broker: $18,000 = C$30,000 x $.60 spot rate Accounts Payable (C$) 18,000 Foreign Currency Units (C$) 18,000 Settle foreign currency payable.


11-20

E11-10 Purchase with Forward Exchange Contract and Intervening Fiscal Year-End

12/16 12/31 2/14

Transaction Date Balance Sheet Settlement Date — Payable in SFr date — Receive SFr — Sign FEC to from FEC receive SFr — Settle payable in SFr Forward rate: SFr 1 = $.67 SFr 1 = $.695Spot rate: SFr 1 = $.68 SFr 1 = $.70 SFr 1 = $.69

PART I: Forward contract not a designated hedge. a. December 16, 20X7 Equipment 95,200 Accounts Payable (SFr) 95,200 Purchased equipment with payable denominated in SFr: $95,200 = SFr 140,000 x $.68 spot rate Foreign Currency Receivable from Broker (SFr) 93,800 Dollars Payable to Exchange Broker ($) 93,800 Signed 60-day forward exchange contract: $93,800 = SFr 140,000 x $.67 forward rate December 31, 20X7 Foreign Currency Transaction Loss 2,800 Accounts Payable (SFr) 2,800 Revalue accounts payable to current U.S. dollar equivalent: $98,000 = SFr 140,000 x $.70 Dec. 31 spot rate - 95,200 = SFr 140,000 x $.68 Dec. 16 spot rate $ 2,800 = SFr 140,000 x ($.70 - $.68) Foreign Currency Receivable from Exchange Broker (SFr) 3,500 Foreign Currency Transaction Gain 3,500 Revalue foreign currency receivable: $97,300 = SFr 140,000 x $.695 Dec. 31 forward rate - 93,800 = SFr 140,000 x $.67 Dec. 16 forward rate $ 3,500 = SFr 140,000 x ($.695 - $.67)


11-21

E11-10 (continued) February 14, 20X8 Foreign Currency Transaction Loss 700 Foreign Currency Receivable from Exchange Broker (SFr) 700 Revalue foreign currency receivable to current equivalent U.S. dollar value: $96,600 = SFr 140,000 x $.69 Feb. 14, 20X8, spot rate - 97,300 = SFr 140,000 x $.695 Dec. 31, 20X7, forward rate $ 700 = SFr 140,000 x ($.69 - $.695) Accounts Payable (SFr) 1,400 Foreign Currency Transaction Gain 1,400 Revalue foreign currency accounts payable to current U.S. dollar value: $96,600 = SFr 140,000 x $.69 Feb. 14, 20X8, spot rate - 98,000 = SFr 140,000 x $.70 Dec. 31, 20X7, spot rate $ 1,400 = SFr 140,000 x ($.69 - $.70) Dollars Payable to Exchange Broker ($) 93,800 Cash 93,800 Pay U.S. dollars to exchange broker for forward contract. Foreign Currency Units (SFr) 96,600 Foreign Currency Receivable from Exchange Broker (SFr) 96,600 Receive francs from exchange broker: $96,600 = SFr 140,000 x $.69 spot rate Accounts Payable (SFr) 96,600 Foreign Currency Units (SFr) 96,600 Settle foreign currency payable. b. Income statement effect for the year ended December 31, 20X7: Foreign Currency Exchange Loss (with Swiss Co.) $(2,800) Foreign Currency Exchange Gain (with Broker) 3,500 Net effect on income $ 700 c. Overall effect of transactions: 20X7 Foreign Currency Gain $ 700 20X8 Foreign Currency Loss on receivable (700) 20X8 Foreign Currency Transaction Gain on payable 1,400 Overall effect $ 1,400


11-22

E11-10 (continued) PART II: Forward contract designated as a cash flow hedge. December 16, 20X7 Equipment 95,200 Accounts Payable (SFr) 95,200 Purchased equipment with payable denominated in SFr: $95,200 = SFr 140,000 x $.68 spot rate Foreign Currency Receivable from Broker (SFr) 93,800 Dollars Payable to Exchange Broker ($) 93,800 Signed 60-day forward exchange contract: $93,800 = SFr 140,000 x $.67 forward rate December 31, 20X7 Foreign Currency Transaction Loss 2,800 Accounts Payable (SFr) 2,800 Revalue accounts payable to current U.S. dollar equivalent: $98,000 = SFr 140,000 x $.70 Dec. 31 spot rate - 95,200 = SFr 140,000 x $.68 Dec. 16 spot rate $ 2,800 = SFr 140,000 x ($.70 - $.68) Foreign Currency Receivable from Exchange Broker (SFr) 3,500 Other Comprehensive Income 3,500 Revalue foreign currency receivable with effective portion of change in fair value of cash flow hedging derivative recorded in other comprehensive income: $97,300 = SFr 140,000 x $.695 Dec. 31 forward rate - 93,800 = SFr 140,000 x $.67 Dec. 16 forward rate $ 3,500 = SFr 140,000 x ($.695 - $.67) Other Comprehensive Income 2,800 Foreign Currency Transaction Gain 2,800 In accordance with FASB 138, an amount is reclassified from other comprehensive income to fully offset the foreign currency transaction loss on the revaluation of the foreign currency denominated account payable.


11-23

E11-10 (continued) February 14, 20X8 Other Comprehensive Income 700 Foreign Currency Receivable from Exchange Broker (SFr) 700 Revalue foreign currency receivable to current equivalent U.S. dollar value and record effective portion of change into other comprehensive income in accordance with FASB 138. Forward contract has now expired. $96,600 = SFr 140,000 x $.69 Feb. 14, 20X8, spot rate - 97,300 = SFr 140,000 x $.695 Dec. 31, 20X7, forward rate $ 700 = SFr 140,000 x ($.69 - $.695) Accounts Payable (SFr) 1,400 Foreign Currency Transaction Gain 1,400 Revalue foreign currency accounts payable to current U.S. dollar value using the spot rate in accordance with FASB 52: $96,600 = SFr 140,000 x $.69 Feb. 14, 20X8, spot rate - 98,000 = SFr 140,000 x $.70 Dec. 31, 20X7, spot rate $ 1,400 = SFr 140,000 x ($.69 - $.70) Foreign Currency Transaction Loss 1,400 Other Comprehensive Income 1,400 In accordance with FASB 138, an amount is reclassified from other comprehensive income to fully offset the foreign currency transaction gain on the revaluation of the foreign currency denominated account payable. Dollars Payable to Exchange Broker ($) 93,800 Cash 93,800 Pay U.S. dollars to exchange broker for forward contract. Foreign Currency Units (SFr) 96,600 Foreign Currency Receivable from Exchange Broker (SFr) 96,600 Receive francs from exchange broker: $96,600 = SFr 140,000 x $.69 spot rate Accounts Payable (SFr) 96,600 Foreign Currency Units (SFr) 96,600 Settle foreign currency payable.

Note that there is a remaining credit balance of $1,400 in Other Comprehensive Income. This represents the initial discount on the forward contract and will be reclassified into earnings in alignment with the depreciation on the equipment that was acquired.


11-24

E11-11 Foreign Currency Transactions [AICPA Adapted] 1. d 20X1 20X2 $.4895 x €30,000 $14,685 $.4845 x €30,000 $14,535 $.4845 x €30,000 14,535 $.4945 x €30,000 14,835 Gain $ 150 Loss $ (300)

2. b January 15 Foreign Currency Units (LCU) 300,000 Exchange Loss 15,000 Accounts Receivable (LCU) 315,000 Collect foreign currency receivable and recognize foreign currency transaction loss for changes in exchange rates: $300,000 = (LCU 900,000 / LCU 3) Jan. 15 value - 315,000 = Dec. 31 U.S. dollar equivalent $ 15,000 Foreign currency transaction loss

3. d $120,000 = July 1, 20X1, U.S. dollar equivalent value $140,000 = December 31, 20X1, U.S. dollar equivalent value (LCU 840,000 / $140,000) = LCU 6 / $1 -105,000 = July 1, 20X2, U.S. dollar equivalent value (LCU 840,000 / 8) = $105,000 $(35,000) Foreign currency transaction loss

4. c C$1 / $.90 (C$1.11 = $1.00)

5. d $280,000 = July 1, 20X5, U.S. dollar equivalent value -240,000 = December 31, 20X4, U.S. dollar equivalent value $ 40,000 Foreign currency transaction loss

6. d

7. d


11-25

E11-12 Sale in Foreign Currency a. October 1 December 1 April 1

Transaction Balance Sheet Settlement Date Date Date Direct exchange rates P 1 = $.0068 $.0078 $.0076 Dollar Dollar Weakened Strengthened (rate increased) (rate decreased)

b. October 1, 20X6 Accounts Receivable (P) 34,000 Sales Revenue 34,000 Sold equipment with receivable denominated in pesetas(P): $34,000 = P 5,000,000 x $.0068 December 31, 20X6 Accounts Receivable (P) 5,000 Foreign Currency Transaction Gain 5,000 Revalue foreign currency receivable to current U.S. dollar equivalent: $39,000 = P 5,000,000 x $.0078 Dec. 31 spot rate - 34,000 = P 5,000,000 x $.0068 Oct. 1 spot rate $ 5,000 = P 5,000,000 x ($.0078 - $.0068) April 1, 20X7 Foreign Currency Transaction Loss 1,000 Accounts Receivable (P) 1,000 Revalue foreign receivable to current U.S. dollar equivalent: $38,000 = P 5,000,000 x $.0076 April 1 spot rate - 39,000 = P 5,000,000 x $.0078 Dec. 31 spot rate $ 1,000 = P 5,000,000 x ($.0076 - $.0078) Foreign Currency Units (P) 38,000 Accounts Receivable (P) 38,000 Collect foreign receivable: $38,000 = P 5,000,000 x $.0076 c. Net foreign currency transaction gain = $4,000 October 1 to December 31 = $5,000 gain January 1 to April 1 = (1,000) loss $4,000 gain Proof: $4,000 = P 5,000,000 x ($.0076 - $.0068)


11-26

E11-13 Sale with Forward Exchange Contract

April 20 June 19

Transaction Date Settlement Date — Receivable in kronor

— Receive kronor from receivable

— Sign FEC to deliver

— Complete FEC with delivery of

kronor kronor Forward rate: SKr 1 = $.167 Spot rate: SKr 1 = $.170 SKr 1 = $.165 a. April 20 Accounts Receivable (SKr) 34,000 Sales Revenue 34,000 $34,000 = SKr 200,000 x $.17 spot rate Dollars Receivable from Exchange Broker 33,400 Foreign Currency Payable to Exchange Broker (SKr) 33,400 Sign 60-day forward exchange contract to deliver kronor: $33,400 = SKr 200,000 x $.167 forward rate June 19 Foreign Currency Transaction Loss 1,000 Accounts Receivable (SKr) 1,000 Revalue foreign currency receivable to current equivalent U.S. dollar value: $33,000 = SKr 200,000 x $.165 June 19 spot rate - 34,000 = SKr 200,000 x $.170 April 20 spot rate $ 1,000 = SKr 200,000 x ($.165 - $.170) Foreign Currency Payable to Exchange Broker (SKr) 400 Foreign Currency Transaction Gain 400 Revalue foreign currency payable to current U.S. dollar value: $33,000 = SKr 200,000 x $.165 June 19 spot rate - 33,400 = SKr 200,000 x $.167 April 20 forward rate $ 400 = SKr 200,000 x $.002


11-27

E11-13 (continued) Foreign Currency Units (SKr) 33,000 Accounts Receivable (SKr) 33,000 Receive kronor from foreign receivable: $33,000 = SKr 200,000 x $.165 spot rate Foreign Currency Payable to Exchange Broker (SKr) 33,000 Foreign Currency Units (SKr) 33,000 Pay foreign currency units to exchange broker for forward payable contract. Cash 33,400 Dollars Receivable from Exchange Broker ($) 33,400 Receive U.S. dollars in accordance with rate established in forward exchange contract. b. Effects on net income: Use of forward contract: 1) Dollar strengthened from April 20 to June 19 Exchange loss of $1,000 on foreign currency receivable Exchange gain of $400 for foreign currency payable to exchange broker; therefore, net effect loss $(600) If Alman had not acquired the forward contract: 1) Dollar strengthened resulting in exchange loss of $1,000 on foreign currency receivable from customer (1,000) Difference $ (400) Hedging with the forward exchange contract resulted in $400 less charged to net

income; thus, net income was higher as a result of acquiring the forward contract.


11-28

E11-14 Foreign Currency Transactions [AICPA Adapted] 1. c $4,000

Accounts Payable (€) (200,000 x $.4875) 12/10/X3 97,500

AJE 4,000 (200,000 x $.4675) 12/31/X3 93,500

Accounts Payable (€) 4,000 Foreign Exchange Gain 4,000

2. d $27,000 = $6,000 + $20,000 + $1,000

Accounts Payable (FCU) 1/20/X2 90,000 AJE 6,000 3/20/X2 96,000 Foreign Exchange Loss 6,000 Accounts Payable (FCU) 6,000

Notes Payable (FCU) 7/01/X2 500,000 AJE 20,000 12/31/X2 520,000 Foreign Exchange Loss 20,000 Notes Payable (FCU) 20,000

Interest Payable (FCU) ($500,000 x .10 x 1/2 year) 25,000 AJE 1,000 12/31X2 26,000 Foreign Exchange Loss Interest Payable (FCU) 1,000 1,000


11-29

E11-14 (continued) 3. c $5,000

Accounts Receivable (FCU)10/15/X1 100,000

AJE 5,000

11/16/X1 105,000 Settlement 11/16/X1 105,000

Accounts Receivable (FCU) 5,000 Foreign Exchange Gain 5,000

Note: The receivable is recorded on October 15, 20X1, when the goods were shipped, not on September 1, 20X1, when the order was received.

4. b $1,000

Accounts Payable (FCU)

(10,000 x $.60) 4/08/X3 6,000X3 AJE 500

(10,000 x $.55) 12/31/X3 5,500

X4 AJE 1,000 (10,000 x $.45) 3/01/X4 4,500

Settlement 4,500 Bal. -0- X4 AJE Accounts Payable (FCU) 1,000

Foreign Exchange Gain 1,000


11-30

E11-14 (continued) 5. b A gain should be reported because the peso weakened from December 15

(the transaction date) to the balance sheet date (December 31, 20X5). Stevens would not record the purchase until title transferred on December 15, 20X5. The accounts payable recorded on December 15 are denominated in pesos when the indirect exchange rate was $1 = 20 pesos. On December 31, 20X5, the indirect exchange rate was $1 = 21 pesos, meaning that the dollar strengthened and the peso weakened. Therefore, a foreign currency transaction gain would be reported for 20X5. This gain would be included in net income before extraordinary items.

6. b Foreign currency transaction gains and losses are reported on the income

statements of U.S. companies when receivables and payables are denominated in foreign currencies. Since Louis did not report any foreign exchange gains or losses, the payable to the German company was denominated in U.S. dollars, not European euros.

7. b $9,000 = 300,000 pounds x ($1.65 - $1.62). The foreign currency transaction

gain is computed using spot rates on the transaction date (November 30, 20X5) and the balance sheet date (December 31, 20X5). The forward exchange rates are not used because the transaction was not hedged.


11-31

E11-15 Sale with Forward Contract and Fiscal Year-End May 14 June 30 July 13

Transaction Date Balance Sheet Settlement Date Date — Sale with receivable — Collect receivable denominated in guilders in guilders — Enter into 60-day FEC — Complete FEC with to deliver guilders delivery of guilders

Forward rate: G 1 = $.541 G 1 = $.530Spot rate: G 1 = $.530 G 1 = $.534 G 1 = $.525 a. 1. May 14 Accounts Receivable (G) 26,500 Sales Revenue 26,500 Foreign currency sale: $26,500 = G 50,000 x $.530 2. May 14 Dollars Receivable from Exchange Broker 27,050 Foreign Currency Payable to Exchange Broker (G) 27,050 Signed 60-day forward contract to deliver guilders: $27,050 = G 50,000 x $.541 forward rate 3. June 30 Accounts Receivable (G) 200 Foreign Currency Transaction Gain 200 Revalue foreign currency receivable to end-of-period U.S. dollar equivalent using spot rate according to FASB 52: $26,700 = G 50,000 x $.534 June 30 spot rate - 26,500 = G 50,000 x $.530 May 14 spot rate $ 200 = G 50,000 x ($.534 - $.530) Foreign Currency Payable to Exchange Broker (G) 550 Foreign Currency Transaction Gain 550 Revalue foreign currency payable to year-end fair value using forward rate according to FASB 133: $26,500 = G 50,000 x $.530 June 30 forward rate - 27,050 = G 50,000 x $.541 May 14 forward rate $ 550 = G 50,000 x $.011


11-32

E11-15 (continued) 4. July 13 Foreign Currency Transaction Loss 450 Accounts Receivable (G) 450 Revalue foreign currency receivable to U.S. dollar equivalent on settlement date: $26,250 = G 50,000 x $.525 July 13 spot rate - 26,700 = G 50,000 x $.534 June 30 spot rate $ 450 = G 50,000 x ($.525 - $.534) Foreign Currency Units (G) 26,250 Accounts Receivable (G) 26,250 Collect foreign currency receivable. 5. July 13 Foreign Currency Payable to Exchange Broker (G) 250 Foreign Currency Transaction Gain 250 Revalue foreign currency payable to fair value at settlement date using spot rate because the term of the contract has expired: $26,250 = G 50,000 x $.525 July 13 spot rate - 26,500 = G 50,000 x $.530 June 30 forward rate $ 250 = G 50,000 x $.005 Foreign Currency Payable to Exchange Broker (G) 26,250 Foreign Currency Units (G) 26,250 Pay guilders to exchange broker. Cash 27,050 Dollars Receivable from Exchange Broker 27,050 Receive dollars from exchange broker for guilders delivered: $27,050 = G 50,000 x $.541 rate established in forward contract signed on May 14. b. June 30 FCT gain on account from Netherlands Company $200 FCT gain on account to Broker 550 Net increase in net income for FYE June 30 $750


11-33

E11-15 (continued) c. July 13 FCT loss on account receivable from Netherlands Company $(450) FCT gain on account to Broker 250 Net decrease in net income for the period from 7-1 to 7-13 $(200) Net increase in net income for the FYE 6-30 750 Overall gain on transaction $ 550 d. May 14 — June 30 gain $ 200 July 1 — July 13 loss (450) Overall loss if forward contract not used $(250)


11-34

E11-16A Hedge of a Purchase (Commitment without and with Time Value of Money Consideration)

11/1/X6 12/31/X6 1/30/X7 3/1/X7

— Commitment Balance Sheet Transaction Settlement to deliver Date Date Date pounds in — Receipt of — Receive British120 days goods and pounds from

— Sign FEC to recognition settlement ofhedge foreign of foreign FEC currency currency — Pay pounds tocommitment payable settle foreign

currency accounts payable Forward rate:

£1 = $1.59 £1 = $1.62 £1 = $1.60Spot rate:

£1 = $1.61 £1 = $1.65 £1 = $1.59 £1 = $1.585 a. No net exposure between November 1 and March 1. Smith Imports, Inc., has

hedged its foreign currency purchase commitment with a forward contract to receive an equal number of foreign currency units. Note that the notional amount of the forward exchange contract, the unrecognized firm commitment, and the eventual foreign currency-denominated account payable are each for £30,000. The impact on earnings from the forward contract will be a total of $600, which is the amount of the discount on the forward contract ((£30,000 x ($1.61 spot rate — $1.59 forward rate)). [The subsequent analysis will show that $300 of the $600 will adjust the inventory that will impact earnings when the inventory is sold, and the remaining $300 will be recognized in earnings through the revaluation process.]

b. November 1, 20X6 Foreign Currency Receivable from Exchange Broker (£) 47,700 Dollars Payable to Exchange Broker ($) 47,700 Signed 120-day forward contract to hedge foreign currency commitment: $47,700 = £30,000 x $1.59 forward rate


11-35

E11-16A (continued) December 31, 20X6 Foreign Currency Receivable from Exchange Broker (£) 900 Foreign Currency Transaction Gain 900 Revalue foreign currency receivable to end-of-period fair value: $48,600 = £30,000 x $1.62 Dec. 31 forward rate - 47,700 = £30,000 x $1.59 Nov. 1 forward rate $ 900 = £30,000 x ($1.62 - $1.59) Foreign Currency Transaction Loss 900 Firm Commitment 900 Record the loss on the firm commitment: $900 = £30,000 x ($1.62 - $1.59) January 30, 20X7 Foreign Currency Transaction Loss 600 Foreign Currency Receivable from Exchange Broker (£) 600 Revalue foreign currency receivable to current U.S. dollar equivalent: $48,000 = £30,000 x $1.60 Jan. 30 forward rate - 48,600 = £30,000 x $1.62 Dec. 31 forward rate $ 600 = loss, £30,000 x ($1.60 - $1.62) Firm Commitment 600 Foreign Currency Transaction Gain 600 Record the gain on the financial instrument aspect of the firm commitment: $600 = £30,000 x ($1.60 - $1.62) Inventory (or Purchases) 47,400 Firm Commitment 300 Accounts Payable (£) 47,700 Record foreign currency account payable at spot rate and recognize change in value of the firm commitment as adjustment of purchase price: $47,700 = £30,000 x $1.59 Jan. 30 spot rate


11-36

E11-16A (continued) March 1, 20X7 Foreign Currency Transaction Loss 450 Foreign Currency Receivable from Exchange Broker (£) 450 Revalue foreign currency receivable to fair value: $47,550 = £30,000 x $1.585 Mar. 1 spot rate - 48,000 = £30,000 x $1.60 Jan. 30 forward rate $ 450 = £30,000 x ($1.585 - $1.60) Accounts Payable (£) 150 Foreign Currency Transaction Gain 150 Revalue foreign payable to equivalent U.S. dollar value: $150 = £30,000 x ($1.585 - $1.59) Dollars Payable to Exchange Broker ($) 47,700 Cash 47,700 Deliver U.S. dollars to exchange broker in accordance with forward exchange contract: $47,700 = £30,000 x $1.59 forward rate Foreign Currency Units (£) 47,550 Foreign Currency Receivable from Exchange Broker (£) 47,550 Receive 30,000 pounds from exchange broker: $47,550 = £30,000 x $1.585 Mar. 1 spot rate Accounts Payable (£) 47,550 Foreign Currency Units (£) 47,550 Settle foreign currency payable with 30,000 pounds received from broker.


11-37

E11-16A (continued) c. Considering the time value of money in valuing the forward contract. November 1, 20X6 Foreign Currency Receivable from Exchange Broker (£) 47,700 Dollars Payable to Exchange Broker ($) 47,700 Signed 120-day forward contract to hedge foreign currency commitment: $47,700 = £30,000 x $1.59 forward rate December 31, 20X6 Foreign Currency Receivable from Exchange Broker (£) 882 Foreign Currency Transaction Gain 882 Revalue foreign currency receivable to discounted end-of-period fair value: $48,600 = £30,000 x $1.62 Dec. 31 forward rate - 47,700 = £30,000 x $1.59 Nov. 1 forward rate $ 900 = £30,000 x ($1.62 - $1.59) $ 882 = NPV (.12 x 2/12, 900) Foreign Currency Transaction Loss 882 Firm Commitment 882 Record the loss on the financial instrument aspect of the firm commitment: $882 = NPV (.12 x 2/12, 900) January 30, 20X7 Foreign Currency Transaction Loss 585 Foreign Currency Receivable from Exchange Broker (£) 585 Revalue foreign currency receivable to current U.S. dollar equivalent: $48,000 = £30,000 x $1.60 Jan. 30 forward rate - 47,700 = £30,000 x $1.59 Nov. 1 forward rate $ 300 = Cumulative Gain $ 297 = NPV (.12 x 1/12, 300) - 882 = gain recognized previously $ (585) = net change in fair value Firm Commitment 585 Foreign Currency Transaction Gain 585 Record the gain on the financial instrument aspect of the firm commitment.


11-38

E11-16A (continued) Inventory (or Purchases) 47,403 Firm Commitment 297 Accounts Payable (£) 47,700 Record foreign currency account payable at spot rate and recognize change in value of the firm commitment as adjustment of purchase price: $47,700 = £30,000 x $1.59 Jan. 30 spot rate March 1, 20X7 Foreign Currency Transaction Loss 447 Foreign Currency Receivable from Exchange Broker (£) 447 Revalue foreign currency receivable to fair value: $47,550 = £30,000 x $1.585 Mar. 1, 20X7, spot rate - 47,700 = £30,000 x $1.59 Nov. 1, 20X6, forward rate $ 150 = cumulative, undiscounted loss over term of forward contract - 297 = previously recognized net gain $ 447 = loss for period Accounts Payable (£) 150 Foreign Currency Transaction Gain 150 Revalue foreign currency payable to equivalent U.S. dollar value: $150 = £30,000 x ($1.585 - $1.59) Dollars Payable to Exchange Broker ($) 47,700 Cash 47,700 Deliver U.S. dollars to exchange broker in accordance with forward exchange contract: $47,700 = £30,000 x $1.59 forward rate Foreign Currency Units (£) 47,550 Foreign Currency Receivable from Exchange Broker (£) 47,550 Receive 30,000 pounds from exchange broker: $47,550 = £30,000 x $1.585 Mar. 1 spot rate Accounts Payable (£) 47,550 Foreign Currency Units (£) 47,550 Settle foreign currency payable with 30,000 pounds received from broker.


11-39

E11-17 Gain or Loss on Speculative Forward Exchange Contract 12/1/X1 12/31/X1 3/1/X2

Sign speculative Balance Sheet Settlement of forward exchange Date speculative contract forward exchange contract Forward rate: €1 = $.58 €1 = $.56Spot rate: €1 = $.60 €1 = $.59 €1 = $.57 a. Effects of speculation on 20X1 income: December 31, 20X1 €120,000 x $.56 = $ 67,200 December 1, 20X1 €120,000 x $.58 = - 69,600 Speculation gain in 20X1 $ (2,400) b. Effects of speculation on 20X2 income: March 1, 20X2 €120,000 x $.57 = $ 68,400 December 31, 20X1 €120,000 x $.56 = - 67,200 Speculation loss in 20X2 $ 1,200 Foreign Currency Payable (€)

12/31/X1 AJE 2,400

(€120,000 x $.58 forward rate for 3/1/X2) 12/1/X1 69,600

(€120,000 x $.56 forward rate for 3/1/X2) 12/31/X1 67,200

3/1/X2 AJE 1,200

(€120,000 x $.57 spot rate on 3/1/X2) 3/1/X2 68,400

December 31, 20X1 AJE Foreign Currency Payable (€) 2,400

Foreign Exchange Gain 2,400 March 1, 20X2

AJE Foreign Exchange Loss 1,200 Foreign Currency Payable (€) 1,200


11-40

E11-18 Speculation in a Foreign Currency 10/1/X1 12/31/X1 3/31/X2

Transaction Date Balance Sheet Date Settlement Date — Enter 180-day — Settle speculative forward speculative exchange contract to contract purchase 50,000,000 yen Forward: ¥1 = $.0075 ¥1 = $.0076Spot: ¥1 = $.0070 ¥1 = $.0073 ¥1 = $.0072 a. October 1, 20X1 Foreign Currency Receivable from Exchange Broker (¥) 375,000 Dollars Payable to Exchange Broker ($) 375,000 Sign 180-day forward contract to receive 50,000,000 yen: $375,000 = ¥50,000,000 x $.0075 forward rate December 31, 20X1 Foreign Currency Receivable from Exchange Broker (¥) 5,000 Foreign Currency Transaction Gain 5,000 Revalue speculative forward contract to equivalent end-of-period U.S. dollar value using forward rate on Dec. 31: $380,000 = ¥50,000,000 x $.0076 Dec. 31 forward rate for Mar. 31, 20X2, settlement - 375,000 = ¥50,000,000 x $.0075 Oct. 1 forward rate for Mar. 31, 20X2, settlement $ 5,000 = ¥50,000,000 x ($.0076 - $.0075)

March 31, 20X2 Foreign Currency Transaction Loss 20,000 Foreign Currency Receivable from Exchange Broker (¥) 20,000 Revalue speculative forward contract to current date, the end of the contract term, using March 31 spot rate: $360,000 = ¥50,000,000 x $.0072 Mar. 31 spot rate - 380,000 = ¥50,000,000 x $.0076 Dec. 31 forward rate for Mar. 31, 20X2 $ 20,000 = ¥50,000,000 x ($.0072 - $.0076) Dollars Payable to Exchange Broker ($) 375,000 Cash 375,000 Deliver U.S. dollars to exchange broker.


11-41

E11-18 (continued) Foreign Currency Units (¥) 360,000 Foreign Currency Receivable from Exchange Broker (¥) 360,000 Receive yen from exchange broker: $360,000 = ¥50,000,000 x $.0072 Cash 360,000 Foreign Currency Units (¥) 360,000 Trade yen for dollars, at bank. b. Streamline Company experienced a net loss of $15,000 ($5,000 gain in 20X1 less

a $20,000 loss in 20X2). This may be checked by determining the difference between the dollars paid to the exchange broker on March 31, 20X2, ($375,000) and the U.S. dollar equivalent value of the foreign currency received on March 31 ($360,000).


11-42

E11-19 Forward Exchange Transactions [AICPA Adapted] 1. a $400 = 10,000 foreign currency units x ($.82 - $.78). The loss is calculated

using only forward rates. On December 31, 20X5, the loss is the difference between the 90-day future rate on November 1 ($.78) and the 30-day future rate on December 31 ($.82).

2. c $1,000 = 50,000 European euros x ($.74 - $.72). The loss is calculated using

only forward rates. On September 30, 20X5, the loss is the difference between the 60-day future rate of $.74 on September 1 and the 30-day future rate of $.72 on September 30, 20X5.

3. b Manage an exposed position:

Value the forward exchange contract (FEC) at its fair value, measured by changes in the forward exchange rate (FER). Note that the question asks only for the effect on income from the forward contract transaction; thus, any effect on income from the foreign currency denominated account payable is not included in the answer.

FER, 12/12/X5 $.90 FER, 12/31/X5 $.93 AJE: Forward Contact Receivable 3,000 Foreign Exchange Gain 3,000 Revalue forward contract: $3,000 = Fr 100,000 x ($.93 - $.90) change in forward rates Foreign Exchange Loss 10,000 Account Payable (Fr) 10,000 Revalue foreign currency payable: $10,000 = Fr 100,000 x ($.98 - $.88) change in spot rates 4. b Hedge of a Firm Commitment: Value FEC based on changes in forward rate. AJE: Forward Contract Receivable 3,000 Foreign Exchange Gain 3,000 Revalue forward contract, using the forward rates. Foreign Exchange Loss 3,000 Firm Commitment 3,000 Recognize loss on firm commitment. Again, note that the question asks only about the effect on income from the

forward contract, not the underlying firm commitment portion of the transaction. 5. b Speculation: Value forward exchange contract at fair value based on changes in the forward rate. AJE: Forward Contract Receivable 3,000 Foreign Exchange Gain 3,000


11-43

SOLUTIONS TO PROBLEMS P11-20 Multiple-Choice Questions on Foreign Currency Transactions 11/1/X8 12/31/X8 1/30/X9

Transaction Date Balance Sheet Date Settlement Date — Purchase with payable — Receive renminbi upon denominated in renminbi settlement of forward exchange — Sign 90-day forward contract exchange to receive — Pay renminbi to renminbi settle foreign currency payable Forward rate: R 1 = $.126 R 1 = $.129Spot rate: R 1 = $.120 R 1 = $.124 R 1 = $.127 1. b November 1, 20X8 Foreign Currency Receivable from Exchange Broker (Renminbi) 12,600 Dollars Payable to Exchange Broker ($) 12,600 Signed 90-day forward exchange contract to purchase 100,000 renminbi: $12,600 = 100,000 renminbi x $.126 forward rate 2. c December 31, 20X8 Foreign Currency Receivable from Exchange Broker (Renminbi) 300 Foreign Currency Transaction Gain 300 Revalue foreign currency receivable to fair value: $300 = 100,000 renminbi x ($.129 - $.126) 3. b January 30, 20X9 Dollars Payable to Exchange Broker ($) 12,600 Cash 12,600 Deliver U.S. dollars to exchange broker in accordance with forward exchange contract: $12,600 = 100,000 renminbi x $.126 contract rate 4. b January 30, 20X9 Dollars Payable to Exchange Broker ($) 12,600 Cash 12,600 Deliver U.S. dollars to exchange broker in accordance with forward exchange contract: $12,600 = 100,000 renminbi x $.126, the 90-day forward rate


11-44

P11-20 (continued) 5. a January 30, 20X9 Foreign Currency Transaction Loss 200 Foreign Currency Receivable from Exchange Broker (Renminbi) 200 Adjust foreign currency receivable to current U.S. dollar equivalent: $12,700 = 100,000 renminbi x $.127 Jan. 30 spot rate - 12,900 = 100,000 renminbi x $.129 Dec. 31 forward rate $ 200 = 100,000 renminbi x ($.127 - $.129) Foreign Currency Units (Renminbi) 12,700 Foreign Currency Receivable from Exchange Broker 12,700 Receive 100,000 renminbi from exchange broker: $12,700 = 100,000 renminbi x $.127 spot rate


11-45

P11-21 Foreign Sales 1. June 6 Accounts Receivable (Dkr) 21,000 Sales Revenues 21,000 Foreign sale and foreign currency receivable: $21,000 = Dkr120,000 x $.175 July 3 Accounts Receivable (Dkr) 36 Foreign Currency Transaction Gain 36 Revalue foreign currency receivable to U.S. dollar equivalent value: $21,036 = Dkr120,000 x $.1753 July 3 spot rate - 21,000 = Dkr120,000 x $.1750 June 6 spot rate $ 36 = Dkr120,000 x ($.1753 - $.1750) Foreign Currency Units (Dkr) 21,036 Accounts Receivable (Dkr) 21,036 Collect accounts receivable in Dkr. 2. July 22 Accounts Receivable (£) 47,400 Sales Revenue 47,400 Foreign sale and foreign currency receivable: $47,400 = £30,000 x $1.58 Dollars Receivable from Exchange Broker ($) 48,900 Foreign Currency Payable to Exchange Broker (£) 48,900 Signed 60-day forward contract to sell pounds: $48,900 = £30,000 x $1.63 forward rate September 20 Accounts Receivable (£) 960 Foreign Currency Transaction Gain 960 Revalue foreign currency receivable: $48,360 = £30,000 x $1.612 Sept. 20 spot rate - 47,400 = £30,000 x $1.58 July 22 spot rate $ 960 = £30,000 x ($1.612 - $1.58)


11-46

P11-21 (continued) Foreign Currency Payable to Exchange Broker (£) 540 Foreign Currency Transaction Gain 540 Revalue foreign currency payable: $48,360 = £30,000 x $1.612 Sept. 20 spot rate - 48,900 = £30,000 x $1.630 July 22 forward rate $ 540 = £30,000 x ($1.612 - $1.630) Foreign Currency Units (£) 48,360 Accounts Receivable (£) 48,360 Receive pounds from customer. Foreign Currency Payable to Exchange Broker (£) 48,360 Foreign Currency Units (£) 48,360 Deliver pounds to broker. Cash 48,900 Dollars Receivable from Exchange Broker ($) 48,900 Receive U.S. dollars from broker in accordance with forward contract. 3. October 11 Accounts Receivable (C$) 51,450 Sales Revenue 51,450 Sale to Canadian firm denominated in Canadian dollars: C$70,000 x $.735 Dollars Receivable from Exchange Broker ($) 51,100 Foreign Currency Payable to Exchange Broker (C$) 51,100 Sign 60-day forward contract to sell Canadian dollars: $51,100 = C$70,000 x $.730 forward rate


11-47

P11-21 (continued) November 10 Foreign Currency Transaction Loss 210 Accounts Receivable (C$) 210 Revalue foreign currency receivable to equivalent U.S. dollar value: $51,240 = C$70,000 x $.732 Nov. 10 spot rate - 51,450 = C$70,000 x $.735 Oct. 11 spot rate $ 210 = C$70,000 x ($.732- $.735) Foreign Currency Transaction Loss 140 Foreign Currency Payable to Exchange Broker (C$) 140 Revalue foreign currency payable: $51,240 = C$70,000 x $.732 Nov. 10 spot rate - 51,100 = C$70,000 x $.730 Oct. 11 forward rate $ 140 = C$70,000 x ($.732 - $.730) Foreign Currency Units (C$) 51,240 Accounts Receivable (C$) 51,240 Receive Canadian dollars from customer: $51,240 = C$70,000 x $.732 Nov. 10 spot rate. Foreign Currency Payable to Exchange Broker (C$) 51,240 Foreign Currency Units (C$) 51,240 Deliver Canadian dollars to broker. Cash 51,100 Dollars Receivable from Exchange Broker ($) 51,100 Receive U.S. dollars from broker in accordance with forward contract rate.


11-48

P11-22 Foreign Currency Transactions 1. January 15 Accounts Receivable 7,400 Sales Revenue 7,400 Foreign export denominated in U.S. dollars. March 15 Cash 7,400 Accounts Receivable 7,400 Collect receivable from South Korean firm. 2. March 8 Inventory (or Purchases) 11,760 Accounts Payable (IR£) 11,760 Foreign inventory purchase with payable denominated in foreign currency: $11,760 = IR£7,000 x $1.68 May 1 Accounts Payable (IR£) 140 Foreign Currency Transaction Gain 140 Revalue foreign currency payable to current U.S. dollar equivalent: $11,620 = IR£7,000 x $1.66 May 1 spot rate - 11,760 = IR£7,000 x $1.68 Mar. 8 spot rate $ 140 = IR£7,000 x ($1.66 - $1.68) Globe Shipping must settle the payable in foreign currency units. Foreign currency

units or foreign currency drafts (checks written in terms of foreign currency units) may be obtained from most major banks.

Accounts Payable (IR£) 11,620 Foreign Currency Units (IR£) 11,620 Settlement of foreign currency payable: $11,620 = IR£7,000 x $1.66 May 1 spot rate


11-49

P11-22 (continued) 3. May 12 Foreign Currency Receivable from Exchange Broker (NT$) 3,008 Dollars Payable to Exchange Broker ($) 3,008 Signed 120-day forward contract to hedge a foreign currency commitment: $3,008 = NT$80,000 x $.0376 forward rate August 1 Foreign Currency Receivable from Exchange Broker (NT$) 16 Foreign Currency Transaction Gain 16 Revalue foreign currency receivable to fair value $3,024 = NT$80,000 x $.0378 Aug. 1 forward rate - 3,008 = NT$80,000 x $.0376 May 12 forward rate $ 16 = NT$80,000 x ($.0378 - $.0376) Foreign Currency Transaction Loss 16 Firm Commitment 16 Record the loss on the financial statement aspect of the firm commitment: $16 = NT$80,000 x ($.0378 - $.0376) Inventory (or Purchases) 2,984 Firm Commitment 16 Accounts Payable (NT$) 3,000 Receipt of goods and adjustment of inventory cost by deferrals: $3,000 = NT$80,000 x $.0375 Aug. 1 spot rate


11-50

P11-22 (continued) September 9 Foreign Currency Transaction Loss 48 Foreign Currency Receivable from Exchange Broker (NT$) 48 Revalue foreign currency receivable to fair value: $2,976 = NT$80,000 x $.0372 Sept. 9 spot rate - 3,024 = NT$80,000 x $.0378 Aug. 1 forward rate $ 48 = NT$80,000 x ($.0372 - $.0378) Accounts Payable (NT$) 24 Foreign Currency Transaction Gain 24 Revalue foreign currency payable: $24 = NT$80,000 x ($.0372 - $.0375) Dollars Payable to Exchange Broker ($) 3,008 Cash 3,008 Deliver U.S. dollars to forward exchange broker. Foreign Currency Units (NT$) 2,976 Foreign Currency Receivable from Exchange Broker (NT$) 2,976 Receive Taiwan dollars from exchange broker: $2,976 = NT$80,000 x $.0372 Sept. 9 spot rate. Accounts Payable (NT$) 2,976 Foreign Currency Units (NT$) 2,976 Settle foreign currency payable.


11-51

P11-22 (continued) 4. June 6 Accounts Receivable (€) 90,000 Sales Revenues 90,000 Export sale denominated in euros: $90,000 = €150,000 x $.600 July 6 Dollars Receivable from Exchange Broker ($) 87,000 Foreign Currency Payable to Exchange Broker (€) 87,000 Signed 60-day forward contract to deliver euros: $87,000 = €150,000 x $.580 forward rate September 4 Foreign Currency Transaction Loss 2,250 Accounts Receivable (€) 2,250 Revalue foreign currency receivable to equivalent U.S. dollar value: $87,750 = €150,000 x $.585 Sept. 4 spot rate - 90,000 = €150,000 x $.600 June 6 spot rate $ 2,250 = €150,000 x ($.585 - $.600) Foreign Currency Transaction Loss 750 Foreign Currency Payable to Exchange Broker (€) 750 Revalue foreign currency payable for loss since July 6: $87,750 = €150,000 x $.585 Sept. 4 spot rate - 87,000 = €150,000 x $.580 July 6 forward rate $ 750 = €150,000 x ($.585 - $.580) Foreign Currency Units (€) 87,750 Accounts Receivable (€) 87,750 Receive euros from customer: $87,750 = €150,000 x $.585 Sept. 4 spot rate. Foreign Currency Payable to Exchange Broker (€) 87,750 Foreign Currency Units (€) 87,750 Deliver euros to exchange broker. Cash 87,000 Dollars Receivable from Exchange Broker ($) 87,000 Receive U.S. dollars from broker in accordance with forward contract signed on July 6: $87,000 = €150,000 x $.580 forward contract rate.


11-52

P11-23A Comprehensive Problem: Four Uses of Forward Exchange Contracts without and with Time Value of Money Considerations

a. Use of forward contract to manage foreign currency risk of exposed foreign

currency position. Not designated as a hedge. 12/1/X1 12/31/X1 3/31/X2

Transaction Date Balance Sheet

Date Settlement Date

— Purchase of furniture — Settle forward resulting in foreign exchange contract currency payable and receive — Sign foreign exchange 100,000 Australian contract to receive dollars Australian dollars on — Pay foreign March 31 currency payable Forward rate: A$1 = $.609 A$1 = $.612Spot rate: A$1 = $.600 A$1 = $.610 A$1 = $.602 December 1, 20X1 Inventory (or Purchases) 60,000 Accounts Payable (A$) 60,000 Foreign currency payable: $60,000 = A$100,000 x $.600 Foreign Currency Receivable from Exchange Broker (A$) 60,900 Dollars Payable to Exchange Broker ($) 60,900 Signed forward exchange contract to manage exposed foreign currency payable: $60,900 = A$100,000 x $.609 forward rate December 31, 20X1 Foreign Currency Transaction Loss 1,000 Accounts Payable (A$) 1,000 Revalue foreign currency payable to equivalent U.S. dollar value: $61,000 = A$100,000 x $.610 Dec. 31 spot rate - 60,000 = A$100,000 x $.600 Dec. 1 spot rate $ 1,000 = A$100,000 x ($.610 - $.600) Foreign Currency Receivable from Exchange Broker (A$) 300 Foreign Currency Transaction Gain 300 Revalue foreign currency receivable: $61,200 = A$100,000 x $.612 Dec. 31 forward rate - 60,900 = A$100,000 x $.609 Dec. 1 forward rate $ 300 = A$100,000 x ($.612 - $.609) P11-23A (continued)


11-53

Note: For this case, no entry necessary on January 30, 20X2. March 31, 20X2 Foreign Currency Transaction Loss 1,000 Foreign Currency Receivable from Exchange Broker (A$) 1,000 Revalue foreign currency receivable: $60,200 = A$100,000 x $.602 Mar. 31, 20X2, spot rate - 61,200 = A$100,000 x $.612 Dec. 31, 20X1, forward rate $ 1,000 = A$100,000 x ($.602 - $.612) Accounts Payable (A$) 800 Foreign Currency Transaction Gain 800 Revalue foreign currency payable: $60,200 = A$100,000 x $.602 Mar. 31, 20X2, spot rate - 61,000 = A$100,000 x $.610 Dec. 31, 20X1, spot rate $ 800 = A$100,000 x ($.602 - $.610) Dollars Payable to Exchange Broker ($) 60,900 Cash 60,900 Deliver U.S. dollars to exchange broker as required by forward contract. Foreign Currency Units (A$) 60,200 Foreign Currency Receivable from Exchange Broker (A$) 60,200 Receive A$100,000 from exchange broker in accordance with forward contract: $60,200 = A$100,000 x $.602 Mar. 31 spot rate. Accounts Payable (A$) 60,200 Foreign Currency Units (A$) 60,200 Deliver A$100,000 to creditor.


11-54

P11-23A (continued) b. Use of forward contract as fair value hedge of foreign currency firm commitment.

12/1/X1 12/31/X1 1/30/X2 3/31/X2

Commitment Balance Sheet Transaction Settlement Date Date Date Date — Sign foreign — Purchase of — Settle exchange contract furniture foreign to hedge foreign resulting currency currency payable in foreign commitment firm commitment currency and receive payable A$100,000 — Pay foreign currency payable Forward rate: A$1 = $.609 A$1 = $.612 A$1 = $.605Spot rate: A$1 = $.600 A$1 = $.610 A$1 = $.608 A$1 = $.602 December 1, 20X1 Foreign Currency Receivable from Exchange Broker (A$) 60,900 Dollars Payable to Exchange Broker ($) 60,900 Signed 120-day forward contract to hedge foreign currency commitment to purchase furniture on January 30 for A$100,000: $60,900 = A$100,000 x $.609 forward rate December 31, 20X1 Foreign Currency Receivable from Exchange Broker (A$) 300 Foreign Currency Transaction Gain 300 Revalue foreign currency receivable to fair value: $61,200 = A$100,000 x $.612 Dec. 31 forward rate - 60,900 = A$100,000 x $.609 Dec. 1 forward rate $ 300 = A$100,000 x ($.612 - $.609) Foreign Currency Transaction Loss 300 Firm Commitment 300 Record the loss on the financial instrument aspect of the firm commitment: $300 = A$100,000 x ($.612 - $.609)


11-55

P11-23A (continued) January 30, 20X2 Foreign Currency Transaction Loss 700 Foreign Currency Receivable from Exchange Broker (A$) 700 Revalue foreign currency receivable to current U.S. dollar equivalent: $60,500 = A$100,000 x $.605 Jan. 30, 20X2, forward rate - 61,200 = A$100,000 x $.612 Dec. 31, 20X1, forward rate $ 700 = A$100,000 x ($.605 - $.612) Firm Commitment 700 Foreign Currency Transaction Gain 700 Record the gain on the financial instrument aspect of the firm commitment: $700 = A$100,000 x ($.605 - $.612) Inventory (or Purchases) 61,200 Firm Commitment 400 Accounts Payable (A$) 60,800 Acquire furniture initially committed to on December 1, 20X1: $60,800 = A$100,000 x $.608 spot rate


11-56

P11-23A (continued) March 31, 20X2 Foreign Currency Transaction Loss 300 Foreign Currency Receivable from Exchange Broker (A$) 300 Revalue foreign currency receivable: $60,200 = A$100,000 x $.602 Mar. 31 spot rate - 60,500 = A$100,000 x $.605 Jan. 30 forward rate $ 300 = A$100,000 x ($.602 - $.605) Accounts Payable (A$) 600 Foreign Currency Transaction Gain 600 Revalue foreign currency payable: $60,200 = A$100,000 x $.602 Mar. 31 spot rate - 60,800 = A$100,000 x $.608 Jan. 30 spot rate $ 600 = A$100,000 x ($.602 - $.608) Dollars Payable to Exchange Broker ($) 60,900 Cash 60,900 Deliver U.S. dollars to exchange broker. Foreign Currency Units (A$) 60,200 Foreign Currency Receivable from Exchange Broker (A$) 60,200 Receive A$100,000 from broker in accordance with forward contract signed on December 1: $60,200 = A$100,000 x $.602 Mar. 31 spot rate. Accounts Payable (A$) 60,200 Foreign Currency Units (A$) 60,200 Deliver A$100,000 to foreign creditor.


11-57

P-11-23A (continued) c. Use of forward contract as cash flow hedge of forecasted foreign currency transaction.

12/1/X1 12/31/X1 1/30/X2 3/31/X2

Commitment Balance Sheet Transaction Settlement Date Date Date Date — Sign foreign — Purchase of — Settle exchange contract furniture foreign to hedge forecasted resulting currency foreign currency in foreign commitment transaction. currency and receive payable A$100,000 — Pay foreign currency payable Forward rate: A$1 = $.609 A$1 = $.612 A$1 = $.605 Spot rate: A$1 = $.600 A$1 = $.610 A$1 = $.608 A$1 = $.602 December 1, 20X1 Foreign Currency Receivable from Exchange Broker (A$) 60,900 Dollars Payable to Exchange Broker ($) 60,900 Signed 120-day forward contract as a cash flow hedge of the forecasted foreign currency transaction of the purchase of furniture on January 30 for A$100,000: $60,900 = A$100,000 x $.609 forward rate December 31, 20X1 Foreign Currency Receivable from Exchange Broker (A$) 300 Other Comprehensive Income 300 Revalue foreign currency receivable to fair value and record OCI for effective portion of change in fair value of the derivative designated as a cash flow hedge: $61,200 = A$100,000 x $.612 Dec. 31 forward rate - 60,900 = A$100,000 x $.609 Dec. 1 forward rate $ 300 = A$100,000 x ($.612 - $.609)


11-58

P11-23A (continued) January 30, 20X2 Other Comprehensive Income 700 Foreign Currency Receivable from Exchange Broker (A$) 700 Revalue foreign currency receivable to current U.S. dollar equivalent and record OCI for the effective portion of the change in fair value of the derivative designated as a cash flow hedge: $60,500 = A$100,000 x $.605 Jan. 30, 20X2, forward rate - 61,200 = A$100,000 x $.612 Dec. 31, 20X1, forward rate $ 700 = A$100,000 x ($.605 - $.612) Inventory (or Purchases) 60,800 Accounts Payable (A$) 60,800 Acquire furniture and value at spot rate: $60,800 = A$100,000 x $.608 spot rate


11-59

P11-23A (continued) March 31, 20X2 Other Comprehensive Income 300 Foreign Currency Receivable from Exchange Broker (A$) 300 Revalue foreign currency receivable and record into OCI the effective portion of change in fair value of derivative designated as a cash flow hedge: $60,200 = A$100,000 x $.602 Mar. 31 spot rate - 60,500 = A$100,000 x $.605 Jan. 30 forward rate $ 300 = A$100,000 x ($.602 - $.605) Accounts Payable (A$) 600 Foreign Currency Transaction Gain 600 Revalue foreign currency payable using spot rate and recognizing change into current earnings as specified by FASB 52: $60,200 = A$100,000 x $.602 Mar. 31 spot rate - 60,800 = A$100,000 x $.608 Jan. 30 spot rate $ 600 = A$100,000 x ($.602 - $.608) Foreign Currency Transaction Loss 600 Other Comprehensive Income 600 In accordance with FASB 138, reclassify amount from OCI sufficient to completely offset the foreign currency transaction gain on the foreign currency payable (A$) that was hedged with a derivative designated as a cash flow hedge. Dollars Payable to Exchange Broker ($) 60,900 Cash 60,900 Deliver U.S. dollars to exchange broker. Foreign Currency Units (A$) 60,200 Foreign Currency Receivable from Exchange Broker (A$) 60,200 Receive A$100,000 from broker in accordance with forward contract signed on December 1: $60,200 = A$100,000 x $.602 Mar. 31 spot rate. Accounts Payable (A$) 60,200 Foreign Currency Units (A$) 60,200 Deliver A$100,000 to foreign creditor. Note: At this point there is still a debit balance of $100 in Other Comprehensive

Income. This balance will be reclassified into earnings at the time the inventory is sold which is the completion of the earnings process of the purchase of the inventory.


11-60

P11-23A (continued) d. Forward contract used for speculative purposes only. 12/1/X1 12/31/X1 3/31/X2



— Sign 120 day — Settle forward speculative contract exchange contract to purchase 100,000 and receive Australian dollars. A$100,000 Forward rate: A$1 = $.609 A$1 = $.612Spot rate: A$1 = $.600 A$1 = $.610 A$1 = $.602 December 1, 20X1 Foreign Currency Receivable from Exchange Broker (A$) 60,900 Dollars Payable to Exchange Broker ($) 60,900 Signed 120-day forward contract for speculation: $60,900 = A$100,000 x $.609 December 31, 20X1 Foreign Currency Receivable from Exchange Broker (A$) 300 Foreign Currency Transaction Gain 300 Revalue foreign currency receivable to equivalent U.S. dollar value: $61,200 = A$100,000 x $.612 Dec. 31 forward rate - 60,900 = A$100,000 x $.609 Dec. 1 forward rate $ 300 = A$100,000 x ($.612 - $.609) March 31, 20X2 Foreign Currency Transaction Loss 1,000 Foreign Currency Receivable from Exchange Broker (A$) 1,000 Revalue foreign currency receivable: $60,200 = A$100,000 x $.602 Mar. 31, 20X2, spot rate - 61,200 = A$100,000 x $.612 Dec. 31, 20X1, forward rate $ 1,000 = A$100,000 x ($.602 - $.612) Dollars Payable to Exchange Broker ($) 60,900 Cash 60,900 Deliver U.S. dollars to forward exchange broker. Foreign Currency Units (A$) 60,200 Foreign Currency Receivable from Exchange Broker (A$) 60,200 Receive A$100,000 from exchange broker: $60,200 = A$100,000 x $.602 spot rate


11-61

P11-23A (continued) e. Use of forward contract to manage exposed foreign currency position, considering

the time value of money at a 12 percent annual rate. Forward contract not designated as a hedge.

12/1/X1 12/31/X1 3/31/X2



— Purchase of furniture — Settle forward resulting in foreign exchange contract currency payable and receive — Sign hedging foreign A$100,000 exchange contract — Pay foreign to receive Australian currency payable dollars on March 31 Forward rate: A$1 = $.609 A$1 = $.612 Spot rate: A$1 = $.600 A$1 = $.610 A$1 = $.602 December 1, 20X1 Inventory (or Purchases) 60,000 Accounts Payable (A$) 60,000 Foreign currency payable: $60,000 = A$100,000 x $.600 Foreign Currency Receivable from Exchange Broker (A$) 60,900 Dollars Payable to Exchange Broker ($) 60,900 Signed forward exchange contract to hedge exposed foreign currency payable: $60,900 = A$100,000 x $.609 forward rate December 31, 20X1 Foreign Currency Transaction Loss 1,000 Accounts Payable (A$) 1,000 Revalue foreign currency payable to equivalent U.S. dollar value: $61,000 = A$100,000 x $.610 Dec. 31 spot rate - 60,000 = A$100,000 x $.600 Dec. 1 spot rate $ 1,000 = A$100,000 x ($.610 - $.600) Foreign Currency Receivable from Exchange Broker (A$) 291 Foreign Currency Transaction Gain 291 Revalue foreign currency receivable: $61,200 = A$100,000 x $.612 Dec. 31 forward rate - 60,900 = A$100,000 x $.609 Dec. 1 forward rate $ 300 = A$100,000 x ($.612 - $.609) cumulative, undiscounted gain from Dec. 1 $ 291 = NPV (.12 x 3/12, 300) for remaining 3 months from 12/31/X1 — 3/31/X2


11-62

P11-23A (continued) Note: For this case, no entry necessary on January 30, 20X2. March 31, 20X2 Foreign Currency Transaction Loss 991 Foreign Currency Receivable from Exchange Broker (A$) 991 Revalue foreign currency receivable: $60,200 = A$100,000 x $.602 Mar. 31, 20X2, spot rate - 60,900 = A$100,000 x $.609 Dec. 1, 20X1, forward rate $ (700) = cumulative, undiscounted loss over term of forward contract - 291 = gain previously recognized on Dec. 31, 20X1 $ (991) = change in fair value this period Accounts Payable (A$) 800 Foreign Currency Transaction Gain 800 Revalue foreign currency payable: $60,200 = A$100,000 x $.602 Mar. 31, 20X2, spot rate - 61,000 = A$100,000 x $.610 Dec. 31, 20X1, spot rate $ 800 = A$100,000 x ($.602 - $.610) Dollars Payable to Exchange Broker ($) 60,900 Cash 60,900 Deliver U.S. dollars to exchange broker as required by forward contract. Foreign Currency Units (A$) 60,200 Foreign Currency Receivable from Exchange Broker (A$) 60,200 Receive A$100,000 from exchange broker in accordance with forward contract: $60,200 = A$100,000 x $.602 Mar. 31 spot rate. Accounts Payable (A$) 60,200 Foreign Currency Units (A$) 60,200 Deliver A$100,000 to creditor.


11-63

P11-24 Foreign Purchases and Sales Transactions and Hedging Part I a. Journal entries for Maple's import and export transactions during 20X5 and 20X6: 1. March 1, 20X5 Accounts Receivable (C$) 19,500 Sales 19,500 $19,500 = C$30,000 x $.65 spot rate May 30, 20X5 Accounts Receivable (C$) 900 Foreign Currency Transaction Gain 900 $900 = C$30,000 x ($.68 - .65) Foreign Currency Units (C$) 20,400 Accounts Receivable (C$) 20,400 $20,400 = C$30,000 x $.68 Cash 20,400 Foreign Currency Units (C$) 20,400 2. July 1, 20X5 No entry is recorded when the contract to purchase equipment is signed. August 30, 20X5 Equipment 52,000 Accounts Payable (¥) 52,000 $52,000 = ¥500,000 x $.104 October 29, 20X5 Foreign Currency Transaction Loss 1,000 Accounts Payable (¥) 1,000 $1,000 = ¥500,000 x ($.106 - $.104) Foreign Currency Units (¥) 53,000 Cash 53,000 $53,000 = ¥500,000 x $.106 Accounts Payable (¥) 53,000 Foreign Currency Units (¥) 53,000


11-64

P11-24 (continued) 3. November 16, 20X5 Inventory 16,500 Accounts Payable (£) 16,500 $16,500 = £10,000 x $1.65 December 31, 20X5 Accounts Payable (£) 200 Foreign Currency Transaction Gain 200 $200 = £10,000 x ($1.63 - $1.65) January 15, 20X6 Foreign Currency Transaction Loss 100 Accounts Payable (£) 100 $100 = £10,000 x ($1.64 - $1.63) Foreign Currency Units (£) 16,400 Cash 16,400 $16,400 = £10,000 x $1.64 Accounts Payable (£) 16,400 Foreign Currency Units (£) 16,400 b. Maple should report a foreign currency transaction gain of $100 on its income

statement for 20X5. This amount is computed as follows: Foreign currency transaction gain from transaction denominated in pounds $ 200 Foreign currency transaction gain from transaction denominated in Canadian dollars 900 Less foreign currency transaction loss from transaction denominated in yen (1,000) Foreign currency transaction gain for 20X5 $ 100


11-65

P11-24 (continued) Part II a. 1. Journal entries for the use of a forward contract to manage the foreign currency exposure of the sale in Canadian dollars: March 1, 20X5 Dollars Receivable from Exchange Broker 19,200 Foreign Currency Payable to 19,200 Exchange Broker (C$) $19,200 = C$30,000 x $.64 forward rate May 30, 20X5 Foreign Currency Transaction Loss 1,200 Foreign Currency Payable to Exchange Broker (C$) 1,200 $20,400 = C$30,000 x $.68 May 30 spot rate - 19,200 = C$30,000 x $.64 March 1 forward rate $ 1,200 = C$ 30,000 x ($.68 - $.64) Foreign Currency Payable to Exchange Broker (C$) 20,400 Foreign Currency Units (C$) 20,400 Cash 19,200 Dollars Receivable from Exchange Broker 19,200


11-66

P11-24 Part II (continued) a. 2. Journal entries for the fair value hedge of the firm

commitment in Japanese yen.

July 1, 20X5 Foreign Currency Receivable from Exchange Broker (¥) 52,500 Dollars Payable to Exchange Broker 52,500 $52,500 = ¥500,000 x $.105 July 1 forward rate August 30, 20X5 Foreign Currency Receivable from Exchange Broker (¥) 250 Foreign Currency Transaction Gain 250 $52,750 = ¥500,000 x $.1055 Aug. 30 forward rate $52,500 = ¥500,000 x $.1050 July 1 forward rate $ 250 = ¥500,000 x ($.1055 - $.1050) Foreign Currency Transaction Loss 250 Firm Commitment 250 Record loss on financial instrument aspect of firm commitment: $250 = ¥500,000 x ($.1055 - $.1050) Equipment 51,750 Firm Commitment 250 Accounts Payable (¥) 52,000 $52,000 = ¥500,000 x $.104 Aug. 30 spot rate October 29, 20X5 Foreign Currency Receivable from Exchange Broker (¥) 250 Foreign Currency Transaction Gain 250 $53,000 = ¥500,000 x $.1060 Oct. 29 spot rate - 52,750 = ¥500,000 x $.1055 Aug. 30 forward rate $ 250 = ¥500,000 x ($.1060 - $.1055) Dollars Payable to Exchange Broker 52,500 Cash 52,500 Foreign Currency Units (¥) 53,000 Foreign Currency Receivable from Exchange Broker (¥) 53,000 $53,000 = ¥500,000 x $.106 Oct. 29 spot rate


11-67

P11-24 Part II (continued) a. 3. Journal entries for the use of a forward contract to manage its foreign

currency exposure in pounds. The forward contract is not designated as a hedge.

November 16, 20X5 Foreign Currency Receivable from Exchange Broker (£) 16,700 Dollars Payable to Exchange Broker 16,700 $16,700 = £10,000 x $1.67 Nov. 16 forward rate December 31, 20X5 Foreign Currency Transaction Loss 250 Foreign Currency Receivable from Exchange Broker (£) 250 $16,450 = £10,000 x $1.645 Dec. 31 forward rate - 16,700 = £10,000 x $1.67 Nov. 16 forward rate $ 250 = £10,000 x ($1.645 - $1.67) January 15, 20X6 Foreign Currency Transaction Loss 50 Foreign Currency Receivable from Exchange Broker (£) 50 $16,400 = £10,000 x $1.640 Jan. 5 spot rate 16,450 = £10,000 x $1.645 Dec. 31 forward rate $ 50 = £10,000 x ($1.640 - $1.645) Dollars Payable to Exchange Broker 16,700 Cash 16,700 Foreign Currency Units (£) 16,400 Foreign Currency Receivable from Exchange Broker (£) 16,400 b. Maple would report a net loss in 20X5 of $1,100, as follows: 20X5 Loss Gain Transaction 1 May 30 Part I - 900 May 30 Part II 1,200 - Transaction 2 Aug. 30, 20X5 — Part II 250 250 Oct. 29, 20X5 — Part I 1,000 - Oct. 29, 20X5 — Part II - 250 Transaction 3 Dec. 31, 20X5 Part I - 200 Dec. 31, 20X5 Part II 250 - 20X5, Net Loss 1,100


11-68

P11-24 Part II (continued) c. Maple would report a net loss in 20X6, of $150, as follows: 20X6 Loss Gain Transaction 3 Jan. 15, 20X6 — Part I 100 - Jan. 15, 20X6 — Part II 50 - 20X6, Net Loss 150 -0-


11-69

P11-25 Understanding Foreign Currency Transactions a. Indirect exchange rates for Australian dollars were: December 1, 20X5: A$70,000 / $42,000 = 1.667 [$1 equals A$1.667] December 31, 20X5: A$70,000 / $41,700 = 1.679 [$1 equals A$1.679] b. The balance in the account Foreign Currency Payable to Exchange Broker was

$39,900 at December 31, 20X5, computed as: $39,900 = A$70,000 x $.57 Dec. 31 forward rate c. The direct exchange rate for the 60-day forward contract for the70,000 Australian

dollars was A$1 = $.58. This is the result of the following computation: ($40,600 / A$70,000) = $.58.

d. $40,600 is the amount of Dollars Receivable from Exchange Broker in the adjusted

trial balance at December 31, 20X5. The balance in this account does not change because it is denominated in U.S. dollars.

e. Indirect spot exchange rates for South Korean wons were: October 2: KRW400,000 / $80,000 = 5 [$1 equals KRW5] December 31: KRW400,000 / $80,800 = 4.950 [$1 equals KRW 4.950] Or, 4.950 = KRW1 / $.2020 f. The Dollars Payable to Exchange Broker was $82,000 in both the adjusted and

unadjusted trial balances. The entry to record the forward contract for the 400,000 South Korean wons on October 2, 20X5, appears below. Note that the account Dollars Payable to Exchange Broker is denominated in U.S. dollars and does not change as a result of exchange rate changes.

Foreign Currency Receivable from Exchange Broker (KRW) 82,000 Dollars Payable to Exchange Broker ($) 82,000 g. The direct exchange rate for the 120-day forward contract in South Korean wons on

October 2, 20X5, was $.205. This amount is determined in the following manner: $82,000 / KRW400,000 = $.205. The $82,000 is the amount of the dollars payable to exchange broker. This amount is computed by using the forward rate.


11-70

P11-25 (continued) h. The accounts payable balance was $80,800 at December 31, 20X5. $80,800 = KRW400,000 x $.2020 Dec. 31 spot rate The entries to support the computations for Problem 11-25 are presented below. 1. Transactions with Australian company December 1, 20X5 Accounts Receivable (A$) 42,000 Sales 42,000 $42,000 = A$70,000 x ($1/A$1.667) Dollars Receivable from Exchange Broker 40,600 Foreign Currency Payable to Exchange Broker (A$) 40,600 $40,600 = A$70,000 x $.58 Dec. 1 forward rate, and also dollar amount stated in problem information ($.58 = $40,600 / A$70,000) December 31, 20X1 Foreign Currency Transaction Loss 300 Accounts Receivable (A$) 300 $300 = change in accounts receivable (A$) as noted in problem information. Foreign Currency Payable to Exchange Broker 700 Foreign Currency Transaction Gain 700 $39,900 = A$70,000 x $.57 Dec. 31 forward rate - 40,600 = A$70,000 x $.58 Dec. 1 forward rate $ 700 = A$70,000 x ($.57 - $.58)


11-71

P11-25 (continued) 2. Transactions with South Korean company October 2, 20X5 Equipment 80,000 Accounts Payable (KRW) 80,000 $80,000 = KRW400,000 x $.20 Foreign Currency Receivable from Exchange Broker (KRW) 82,000 Dollars Payable to Exchange Broker 82,000 $82,000 = KRW400,000 x $.2050, and the $82,000 is presented in the problem for the foreign currency receivable. December 31, 20X5 Foreign Currency Transaction Loss 800 Accounts Payable (KRW) 800 $80,800 = KRW400,000 x $.202 Dec. 31 spot rate - 80,000 = KRW400,000 x $.200 October 2 spot rate $ 800 = KRW400,000 x ($.202 - $.200) Foreign Currency Transaction Loss 1,000 Foreign Currency Receivable from Exchange Broker 1,000 $81,000 = KRW400,000 x $.2025 Dec. 31 forward rate - 82,000 = KRW400,000 x $.2050 Oct. 2 forward rate $ 1,000 = KRW400,000 x ($.2025 - $.2050)


11-72

P11-26 Matching Key Terms

1. E

2. H

3. F

4. A

5. I

6. L

7. O

8. B

9. M

10. C

11. N

12. K

13. J

14. G

15. D P11-27B Multiple-Choice Questions on Derivatives and Hedging Activities 1. d An underlying is a financial or physical variable. 2. c 3. c The net investment must be less than that required for other types. 4. a The change for fair value hedges goes to current earnings. The change for cash flow hedges goes to other comprehensive income. 5. b 6. c Trading securities do not qualify for hedge accounting.


11-73

P11-28B A Cash Flow Hedge: Use of an Option to Hedge an Anticipated Purchase.

a. Entry to record the purchase of the call options on November 30, 20X1: November 30, 20X1 Purchased Call Options 20,000 Cash 20,000 Purchase call options for 10,000 barrels of oil at a premium of $2 per barrel for March 1, 20X2. The options are at the money of $30 per barrel; therefore, the entire $20,000 is time value. b. Adjusting entry on December 31, 20X1: December 31, 20X1 Loss on Hedge Activity 14,000 Purchased Call Options 14,000 Record the decrease in the time value of the options to current earnings. Purchased Call Options 10,000 Other Comprehensive Income 10,000 Record the increase in the intrinsic value of the options to other comprehensive income. c. Entries to record March 1, 20X2, expiration of options, the sale of the options, and the purchase of oil: March 1, 20X2 Loss on Hedge Activity 6,000 Purchased Call Options 6,000 Record the decrease in the time value of the options to current earnings. The options have expired. Purchased Call Options 20,000 Other Comprehensive Income 20,000 Record the increase in the intrinsic value of the options to other comprehensive income. Cash 30,000 Purchased Call Options 30,000 Record the sale of the call options. Oil Inventory 330,000 Cash 330,000 Record the purchase of 10,000 barrels of oil at the spot price of $33 per barrel.


11-74

P11-28B (continued)

d. June 1, 20X2, entries to record the sale of the oil and other entries: June 1, 20X2 Cash 340,000 Sales 340,000 Record the sale of 10,000 barrels of oil at $34 per barrel. Cost of Goods Sold 330,000 Oil Inventory 330,000 Recognize the cost of the oil sold. Other Comprehensive Income – Reclassification 30,000 Cost of Goods Sold 30,000 Reclassify into earnings the other comprehensive income from the cash flow hedge.


11-75

P11-29B A Fair Value Hedge: Use of an Option to Hedge Available-for-Sale Securities.

a. November 3, 20X2, entries: November 3, 20X2 Available-for-Sale Securities 1,200 Cash 1,200 Purchase 100 shares of JRS at $12 per share. Put Option 100 Cash 100 Purchase put options for 100 shares of JRS at $12 per share at a cost of $100. b. December 31, 20X2, entries to record revaluations of stock and options: December 31, 20X2 Put Option 100 Gain on Hedge Activity 100 Record increase in intrinsic value of put options to current earnings. Loss on Hedge Activity 100 Available-for-Sale Securities 100 Record decrease in fair value of hedged available-for-sale securities to current earnings, in accordance with FASB 133: $100 = ($12 - $11) x 100 shares Loss on Hedge Activity 60 Put Option 60 Record decrease in the time value of the options. c. Entries for March 3, 20X3, to record exercise of the put option and the sale of securities: March 3, 20X3 Put Option 50 Gain on Hedge Activity 50 Record increase in intrinsic value of put options to current earnings. Loss on Hedge Activity 50 Available-for-Sale Securities 50 Record decrease in fair value of hedged available-for-sale securities to current earnings, in accordance with FASB 133: $50 = ($11 - $10.50) x 100 shares


11-76

P11-29B (continued)

Loss on Hedge Activity 40 Put Option 40 Record decrease in the time value of the options. The options have now expired. Cash 1,200 Put Option 150 Available-for-Sale Securities 1,050 Exercise the put option and sell securities at option price of $12 per share.

P11-30B Matching Key Terms – Hedging and Derivatives

1. L

2. E

3. M

4. D

5. G

6. I

7. A

8. K

9. H

10. N

11. F

12. B

13. J

14. O

15. C


11-77

P11-31 Determining Financial Statement Amounts Transaction 1 2 3 4Forward Contract Receivable $20,200 $20,200 $20,200 $20,200 Inventory 19,800 21,000 21,000 NA Accounts Payable 19,600 19,600 19,600 NA Foreign Currency Exchange 1,000 G NA 1,000 G 800 G Gain (Loss), net Other Comprehensive Income NA 2,200 G NA NA Gain (Loss), net Computational support: Forward Contract Receivable: $20,200 = €20,000 x $1.01 12/31 forward rate Inventory: $19,800 = $21,000 accounts payable less $1,200 firm commitment

$21,000 = €20,000 x $1.05 11/30 spot rate Accounts Payable: $19,600 = €20,000 x $0.98 12/31 spot rate Foreign Currency Exchange Gain or (Loss), net:

Transaction 1: $1,000 = $ 1,200 exchange gain on forward contract from change in forward rate from 9/1 to 11/30: (€20,000 x ($1.03 -$0.97)) - 1,200 exchange loss on firm commitment for change in forward rate from 9/1 to 11/30: (€20,000 x ($1.03 -$0.97)) - 400 exchange loss on forward contract from change in forward rate from 11/30 to 12/31: (€20,000 x ($1.01 -$1.03)) + 1,400 exchange gain on account payable for change in spot rate from 11/30 to 12/31: (€20,000 x ($0.98 -$1.05))

Transaction 2: No net foreign currency exchange gain because FASB 138

specifies an offset of the gain from the revaluation of the account payable by an equal amount from other comprehensive income.


11-78

P11-31 (continued)

Transaction 3: $1,000 = $1,400 exchange gain on account payable from change in spot rate from 11/30 to 12/31: (€20,000 x ($0.98 -$1.05)) - 400 exchange loss on forward contract from change in forward rate from 9/1 to 12/31: (€20,000 x ($1.01 -$1.03))

Transaction 4: $ 800 = exchange gain on forward contract from change in forward rate from 9/1 to 12/31: (€20,000 x ($1.01 -$0.97)) Other Comprehensive Income Gain or (Loss), net:

Transaction 2: $2,200 = $ 800 OCI gain on forward contract from change in forward rate from 9/1 to 12/31: (€20,000 x ($1.01 -$0.97)) + 1,400 OCI gain on the reclassification from OCI to offset the exchange gain on the account payable from the change in the spot rate from 11/30 to 12/31, as required by FASB 138: (€20,000 x ($0.98 -$1.05))